Participation Mortgage: An Explanation

A participation mortgage refers to a home loan that allows multiple people to team up and share in the real estate investment profits. By splitting the proceeds, they’re also reducing their risk exposure.

While Rocket Mortgage^® does not offer participation mortgages, we understand the importance of educating our clients. Let’s look at how participation mortgages work and how they can benefit both borrowers and lenders.

What Is A Participation Mortgage?

A participation mortgage, also known as a participating mortgage, is a type of loan that allows two or more people to share the proceeds from a piece of property. The lender or mortgagee has the legal right to divide the proceeds from the borrower or mortgagor.

A participating mortgage is also sometimes referred to as participating financing. This agreement can include partnerships between lenders, multiple borrowers or a combination of borrowers and lenders.

Participation mortgages are often used in large commercial real estate transactions, which frequently require multiple lenders to spread the risk. Commercial buildings typically have much higher price points than residential ones, meaning that investors might only be able to afford these properties if they pool their money together.

How Does A Participating Mortgage Loan Work?

An equity participation mortgage occurs when two or more parties share the risk of financing a property. By taking on this risk together, the parties involved in the transaction also share in the proceeds from the rental or sale. These mortgages aren’t as commonplace as they used to be but are sometimes used to finance large real estate transactions.

Let’s look at how participation mortgages work and some of the costs involved.

Cost Of The Loan

• Nontraditional lenders often issue participation mortgages. They usually offer these mortgages at a reduced interest rate in exchange for a portion of the cash flow from the property and some of the resale revenues.
• A participation mortgage splits the net operating income (NOI), which measures a property’s profitability before adding in financing or taxes.
• A lender may receive a one-time payment after the owner sells the property. They may also receive a percentage of the operating cash flow created by the property as long as it’s working.

Types Of Payments

There are various types of payments that a lender can seek for a participation mortgage, and each type can be used in a slightly different way.

• Repayment: The repayment terms will vary depending on the lender and the terms of the mortgage participation agreement. Borrowers will often make either interest-only payments or pay a combination of interest and principal.
• Interest payment: Some participation mortgages come with interest-only payments, which means the monthly payments are often lower in the beginning. If a loan has a 30-year repayment period, the first 10 years might come with interest-only payments.
• Balloon payment: Occasionally, participation mortgages come with a balloon payment at the end of the loan. This comes with smaller monthly payments. Borrowers must typically have high creditworthiness to qualify for the balloon payment structure.

Participating Mortgage Used In Real Estate Investing

Participation loans are used in real estate investing. In particular, they are commonly used in commercial real estate, which predicts the continuous rental income. The borrowers will share in the mortgage and split the proceeds generated from the rental income.

Entrepreneurs will often act as non-traditional lenders in participation loans. These are usually individuals who want to invest in real estate without having to maintain the properties directly. Their investments allow them to earn passive income.

Pros And Cons Of A Participation Mortgage

There are pros and cons to a participation mortgage, both for the borrower and the lender. Here are some of the biggest advantages and disadvantages to consider:

Pros

• Low interest rate: Lenders often charge a lower interest rate for participation mortgages.
• Additional opportunities: Borrowers can access larger real estate loans through joint participation.
• Profit-sharing: Multiple financial institutions are able to share in the profits.
• Low lender risk: It reduces the risk to the lender.
• Diversification: Financial institutions and investors can diversify their financial assets.

Cons

• High risk potential: The larger the loan, the higher the risk of losing money.
• Ample research requirements: Due diligence is crucial as lenders offer riskier loans for participation.

The Bottom Line: Participation Mortgage Opens Real Estate Development To Multiple Parties

A participation mortgage is beneficial both to the lender and borrower, but you’ll need to do your due diligence first. Watch for any red flags in your participation agreement, and make sure the cash flow is divided evenly among all borrowers.

Interested in learning about other ways you can finance real estate investments? Check out our Learning Center or get started with the approval process today with Rocket Mortgage.