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A participation mortgage is a loan contract between borrower and lender that entitles the latter to receive a portion of the income generated by the asset used as collateral.
While these types of loan arrangements are not exclusive to real estate financing, it is most often found in the financing of investment property.
In this case, a part of rental income would be paid to the lender as stipulated by the terms of agreement.
For example, the owner of a strip center might have to send part of the rental income collected from commercial tenants to the lender as part of the agreement. And in return he obtains the required loan amount to acquire the development or receive preferential rates for the debt. Thus, the lender becomes a participant in the deal.
This does not mean that the borrower gets a free pass on the repayments as the principal and interest still has to be properly repaid according to the repayment schedule.
The amount that a lender would be entitled to varies from contract to contract. It can be a specified percentage of income, a split in sale proceeds, or a combination of both.
Also known as participating loans, such loan agreements also entitle the lender to resale proceeds as they are deemed to have a share in the property, effectively becoming equity partners.
In some cases, they can even sell their portions to investors.