Below are several common myths on loan participation agreements circulating in the private lending industry along with explanations on why they are incorrect.
Myth #1 – Only banks can sell participation interest in mortgage loans.
FALSE. Mortgage lenders can kick off a participation agreement with other lenders.
Myth #2 – All Lenders in the participation agreement need to maintain a relationship with the borrower.
FALSE. Only the lead lender needs to manage the borrower relationship. This is a huge benefit for purchasing lenders. In addition, the selling lender must originate the credit, draw up the agreement, and handle any associated services.
Myth #3 – Being the lead lender on a loan participation agreement is more trouble than it’s worth.
FALSE. Although there are inherent risks surrounding a loan participation agreement, there are also many benefits. If lenders properly underwrite, hold evidence, and retain a trusted law firm to facilitate the agreement, the lead lender can successfully generate servicing income, originate larger loans than the legal limit, and more.
Myth #4 – All participations involve the sale of a loan interest.
FALSE. A lead lender may sell either an interest in the loan itself or a contractual right to payment streams from the loan.
Myth #5 – There are no alternatives to a participation agreement.
FALSE. Persons interested in acquiring a fractional interest in a loan should consider the following alternatives in consultation with counsel:
Lead lender receives a loan from a second person that is secured by the underlying loan made by the lead lender.
Loan Sale Agreement
Loan sale agreement addresses sale of fractional interest in a loan. Separate loan administration agreement addresses how the loan will be managed on a going-forward basis.
2 or more lenders make loan “up front” and are the initial lenders on the note.
Myth #6 – All participation agreements are the same.
FALSE. There is a big difference between a thorough participation agreement that responsibly covers the many important details in a complex participation transaction and a “short-form” agreement favored by certain lenders for brevity and simplicity.
Different lenders are concerned with different levels of detail to include in their participation agreements, and a balance should be struck in consultation with counsel.
Myth #7 – The borrower needs to consent to the loan participation.
FALSE. A borrower typically does not have the right to consent to a participation and, in most cases, will be unaware that a lender has sold a participation.
Myth #8 – There are no securities law issues when you sell a fractional loan interest through a participation agreement.
FALSE. There are a variety of securities law concerns that arise whenever a lender tries to sell a fractional interest in a loan.
The securities law issues vary from state to state, so it is very important to consult with securities counsel when structuring a participation transaction.