Which loan type allows a lender to convert a loan into an ownership stake upon borrower default?

The mezzanine loan is a type of financing that sits between senior debt and equity in the capital structure of a project or a company. It is often used in real estate and corporate finance to provide additional capital to borrowers when they don't have sufficient equity. One of the key characteristics of a mezzanine loan is that it typically includes the option for the lender to convert the loan into equity ownership in the asset or company if the borrower defaults. This feature allows lenders to mitigate risk by gaining an ownership stake, giving them more potential to recover their investment if the project becomes successful after default.

This loan type is particularly appealing in scenarios where the potential for high returns exists, as the conversion feature can provide substantial upside to the lender. In other loan types, such as the first loan, second mortgage, or equity loan, similar conversion rights typically do not apply. They do not allow for automatic conversion into ownership stakes upon default, thus distinguishing the mezzanine loan in its unique approach to managing risk and return on investment.