What are mortgage participation bonds?

Published Feb 16, 2007

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Johannesburg - Since Fedbond, South Africa's biggest manager of mortgage participation bond schemes, made the news in recent years, these investment tools have come under the spotlight.

What are participation mortgage bonds and who qualifies to benefit from them? When were these made into law and which law governs them?

These tools give the investor a chance to earn an income from the interest that these schemes charge borrowers who are keen to get involved in commercial and industrial property or finance property transactions. Sold by firms that act as managers between investors and borrowers, these bonds used to be popular among retired people because of the interest income.

This is usually a few percentage points lower than the prevailing prime rate and most investors prefer them to money market funds.

Interest rates are volatile and not fixed. Investors contract into an arrangement where a third party raises money from investors, which is lent to individuals or companies to purchase or develop commercial and industrial properties.

Investors' money is then pooled and placed in a portfolio of loans to reduce the risk to each investor. The initial investment requires a lump sum that is accessible for a five-year period, except under unusual circumstances.

Investors in participation bonds invest their money for a period of five years during which their interest is paid monthly.

Investors would have to give a very compelling story of their hardships if they need to redeem the participation bond. And this is still at the discretion of the manager of the scheme and the regulator, the Financial Services Board. - Mzwandile Jacks

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