The Basics of Loan Participation
In the world of lending there is an entire ocean of possibilities when it comes to making things happen for borrowers. One such commodity, that may be unfamiliar to some, is called loan participation. This post will break down what loan participation is, how it works and how both lenders and borrowers can benefit from it. Hopefully, by the end of this article you'll have a better understanding of this unique form of lending and how you might be able to start utilizing it.
What is a loan participation?
A loan participation, also referred to as a participation loan, happens when multiple lenders work together to fund a single loan. One of the lenders takes the role of “lead lender” and collaborates with the other lenders. The goal is to get each of them to “participate” and purchase an interest in the loan. The lead lender is responsible for all of the due diligence on the loan, and also oversees and manages the entire loan process. The participants simply provide the funding for the loan. In return, they receive a portion of the profits from the loan, as well as share the load of any losses that may occur.
How does loan participation benefit lenders?
Loan participations can be helpful for both small and large lenders, and can offer several benefits, as follows.
With a participation loan, lenders are splitting the risk of a loan with other lenders. By dividing up the risk in this way, each lender takes on a smaller portion of the potential loss, which can help to reduce risk for all involved.
No one would willingly take on more risk unless there was something in it for them, right? Correct. And profit sharing amongst the lending financial institutions in loan participation is the prize, here. The leading lender prepares an agreement for all of the participating lenders to sign. This agreement will outline how profits are to be shared among the lenders, as well as any default provisions.
Larger loan amounts
Offering loan participations allows the leading lender to originate much larger loans that, on their own, would not have been possible. By involving several financial institutions, the lead lender stays within their legal lending limits and still benefits from being able to offer substantial loans.
Control of the customer relationship
The lead lender is the one who gets to manage the borrower relationship, which is a huge benefit to them as they won't lose that customer's business to competing lenders and don't have to share their long-term loyalty either.
Do loan participations benefit borrowers?
Borrowers do not have the right to consent to loan participation arrangements. In fact, they will likely be completely unaware it's going on. Regardless, because of the participation of these lending institutions, they are benefiting from it. Because, since the lenders all have significantly lower risk, they and therefore able to offer the borrower a much lower interest rate than a conventional loan would have allowed for.
Can loan servicing software assist the loan participation process?
“What is loan participation?” In a nutshell, it is a scenario in which the funds for a loan come from multiple sources or participating institutions. And, "why are we telling you about it?" Well, because Nortridge's loan servicing software has an entire wing dedicated to loan participation! The main goal of our participation loan servicing module is to provide all the sub-accounting and payment distribution to each of the participants. There are so many other awesome features! Schedule a demo today to take a closer look at how it works.