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Are you looking to invest in real estate? There are several lending options out there, but if you’re interested in teaming up with other investors to reduce risk and liability, then a participation mortgage may be for you. You can think of it as going in with friends or family on that vacation home you’ve always been talking about – Only this vacation home comes with rental revenue.
By the end of this article, you’ll have a fundamental understanding of:
- What a participation mortgage is and what it is used for.
- Participation mortgage payment structure, costs, and fees.
- The pros and cons of using a participation mortgage.
What Is a Participation Mortgage?
A participation mortgage is amortgage loan that allows several different parties to team up and purchase a property. The parties share responsibility for the loan in addition to any rental income and proceeds from selling. This joint investment gives borrowers more purchasing power, and for lenders, it reduces the risk of default.
How Does a Participation Mortgage Work?
As the name suggests, a participation mortgage involves participation from two or more parties. This can include agreements between borrowers and borrowers, lenders and lenders, or borrowers and lenders.
All parties conjointly share both the risk and the rewards that come with purchasing the property. In many cases, participation mortgages are used for commercial real estate purchases that yield consistent rental income.
Like with any mortgage loan, there will be a qualification process and a set of terms regulating the interest rate and payments.
Participation Mortgage Costs and Fees
You can usually find financing for participation mortgages through non-traditional lenders. This means every lender will come with their own qualification requirements, lending terms, and closing costs. These costs will be on top of standard closing costs such as attorney and government fees.
If you’re teaming up with a hard money or private lender to purchase the property, they may offer the loan at a reduced rate. This comes in exchange for a slice of the property’s revenue. Some borrowing agreements may require the mortgage lenderto receive a one-time payment following the sale of the property.
Various Types of Payments
Every participation mortgage agreement will vary when it comes to loan terms. Lenders could require borrowers to makeinterest-only paymentsor pay for both interest and principal – similarly to a traditional mortgage. Or lenders could opt for balloon payments.
Balloon payments are a type of mortgage loan repayment that involves low monthly payments over the life of the loan. Then, at the end of the loan, the borrower will make a large, lump-sum payment of the remaining balance. The process to qualify for a balloon payment mortgage is often much stricter than other repayment options and depends mainly on income consistency and past payment history.
Another payment option for a participation mortgage is through interest payments. This is similar to making payments on a traditional mortgage loan, meaning monthly payments that consist of both principal and interest.
Your lender may allow you to make interest-only payments. You can expect to have lower monthly payments at the beginning of the repayment stage.
When Are Participation Mortgages Used?
Participation mortgages are typically used in real estate investing, particularly commercial real estate. The end goal is to purchase a property that will bring in a consistent cash flow.
When borrowers and borrowers team up, a participation mortgage allows them to pull resources and purchase properties they may not have qualified for on their own. Not to mention the shared responsibility and liability for the loan.
A borrower and lender team often occurs when the lender has attractive loan terms to offer in exchange for a portion of the revenue and proceeds. This could be a win-win partnership on the right property.
Lenders joining forces with other lenders to make an investment purchase is not uncommon. You may wonder why they’d team up with their competitors, but it’s a good way for them to reduce individual risk and diversify their assets.
Are Participation Mortgages Smart to Use?
Participation mortgages can be a great financing tool when used correctly. If you’ve got your eye on a large piece of commercial real estate you know will bring in a consistent cash flow, then a participation mortgage could make a lot of sense for you. Be sure to do diligent research on the property you’re looking to buy before taking on the responsibility of a participation mortgage. The last thing you want on your plate is an under-performing property next to a significant mortgage commitment.
What Are the Advantages of Participation Mortgages?
For starters, participation mortgages allow borrowers to take on larger projects with reduced risk. This in itself is a huge pull for mortgage investors and investment teams. Not only do you share the responsibility for the payments, but you have a team to consult on matters relating to maintaining the property. If you go in on a purchase with an investor, you could also snag some favorable loan terms you’re unlikely to find elsewhere. For lenders, participation mortgages are often a lower risk and are a great way to diversify assets.
What Are the Disadvantages of Participation Mortgages?
The price you pay for reduced liability with participation mortgages is reduced equity. You aren’t the only one benefiting from the monthly cash flow or the sale proceeds. In addition to splitting income, owning a property with other investors could also bring up conflict regarding property management and other important decisions.
Are Participation Mortgages Safe to Use?
Participation mortgages can be safe if used in the right way and under the right circumstances. As the borrower, you’ll want to do thorough research to ensure this is the best option for you. Lenders may save their riskier loans for participation borrowers, so it’s important to know who you’re borrowing from and that they’re a legitimate partner. Additionally, be sure the property is worth the risk and that it’s the right market setting for this purchase. You don’t want to find yourself in a declining market with a balloon payment mortgage to pay back.
Bottom Line: Participation Mortgages
Participation mortgages can allow investors to make large investment purchases that will produce consistent cash flow. These mortgage loans typically involve a non-traditional lender lending to two or more parties of partnerships between borrowers, lenders, or both. These partners split the liability of the loan in addition to the revenue and sale proceeds.