What is a Leasehold Mortgage?

Leasehold mortgages are loans that are used to aid tenants in financing some type of project associated with land that is leased. Often, this type of mortgage is helpful in providing the resources needed to erect a building or series of buildings on the leased land. For the most part, the lease on the land must be for a number of years before a lender will seriously consider approving the mortgage application.

The utilization of a leasehold mortgage is common with the development of real estate for commercial purposes. For example, a developer may obtain a fifty-year lease on acreage that is already or shortly will be zoned for business use. Once the lease is in place, the developer can secure a leasehold mortgage as a means of obtaining funds to construct a shopping mall on the acreage. Assuming the investment is successful, the mall generates enough revenue to cover both the land lease and repay the leasehold mortgage according to the terms and conditions outlined in the loan contract.

One of the benefits of the leasehold mortgage arrangement is that it allows the developer to proceed without tying up a large amount of his or her assets in the development project. Doing so makes it possible to make the land lease payments and the monthly payments on the mortgage using available capital while the development is underway. Once the project is completed and the development begins to generate income on its own, that revenue stream can be used to pay both the mortgage and the land lease, as well as provide the developer with a steady source of income to use for other projects.

It is important to note that a leasehold mortgage is superseded by the land lease that grants the tenant access to the land, assuming that the lease was in effect prior to the approval of the mortgage. This means that if the tenant defaults on both the lease and the leasehold mortgage, the lease will have priority, since it is considered a first lien. Once the lease is settled, any claims by the lender of the mortgage are addressed and partially or fully settled.

As with any type of lending situation, lenders who offer leasehold mortgages look closely at the credit rating of the loan applicant. Typically, the lender will also want assurance from the landlord that he or she is aware of the development plans of the tenant, and has no objection to those plans. In addition, the lender is likely to look closely at the potential of the project to eventually become self-sustaining and generate enough income to repay the mortgage according to terms. Should the lender believe that the development project does not have a reasonable chance of success, the mortgage application will most likely be rejected.