Mortgage Arrears – Is "Handing Back The Keys" A Solution?

Published on 6/9/2009 in Your Spanish Home

Returning keys to bankPlease note that the information provided in this article is of a general interest nature and intended as a basic outline only. It is not intended as any substitute for detailed legal or other professional advice specific to the reader’s circumstances. Nothing contained in this article should be seen or taken as the writer or publisher providing legal or financial advice.

In the recession of the early 1990’s it became a cliché that certain banks were the UK’s largest private house holders as many owners “handed back the keys” to their properties upon which they could no longer continue to service the mortgage payments. 

A few months ago, when I was writing the TRG Handbook "Buying Distressed Property in Andalucía" I was told that certain Spanish banks were anticipating an avalanche of clients – particularly Ex-Pats – who were in difficulties and would need to seek to resolve their position. More recent reports suggest that the prediction is coming true.

From the banks point of view progressing with formal repossession proceedings is both expensive in terms of time and money. It can take up to three years and cost the bank many thousands of Euros in lost interest and professional fees to recover a property and the legal right to sell to a third party with full title. 

It appears for those facing such miserable circumstances and a potential calamity that another option may exist to defaulting on their mortgage and exposing themselves to a long term battle with their Spanish lender and having a potentially damaging effect on their credit history. 

The solution for some may lie in a legal procedure known as a “Dación en Pago”- in effect “handing back the keys”. 

In practical terms this means signing in the bank’s favour a formal Deed before a Notary which transfers the full legal title to the property from the borrower to the bank, in exchange for which the bank agrees to cancel the balance of outstanding mortgage debt and irrevocably release the borrower from any continuing liability to the bank in respect of the mortgage debt and any outstanding but unpaid interest.  

This formal procedure is established under Article 1.175 of the Spanish Civil Code (SCC). It is important to note that such a transfer, unless otherwise agreed, only releases the borrower from their liability – usually the value of the mortgage - which corresponds to the value of the asset handed over. 

For completeness, the Deed should also include the bank’s waiver of any right that it may have to pursue the Ex-Pat in their home jurisdiction for the debt. As a consequence, the former borrower should not need to disclose to any subsequent lender that they have had a difficulty in Spain and their credit history should be unblemished by their “full and final” settlement with their bank lender.

As always, when a potential solution is highlighted there seems to be a downside. In order to consider whether a Dación en Pago is a potential solution there are three important provisos:

   1. The borrower should – where possible – have not already defaulted in the payment of any mortgage installment;
   2. The lender should not have commenced any formal repossession proceedings and
   3. The target property – vis a vis the mortgage debt - should not suffer from any negative equity. This broadly means that the currently appraised value of the property should exceed the mortgage lending on it.

If the mortgage loan when purchased was based on a high loan to value then given the state of the property market in Spain there is a clear risk that the current value of the property may have fallen since completion such that there is a negative excess of mortgage over value. It has been suggested that headroom of a minimum of 20% between the debt and current value is necessary for a bank to consider the viability of such a scenario.

If the borrower believes that on an independent valuation by an accredited bank valuer or tasador that the value of their property exceeds the outstanding mortgage – and they can envisage no other solution – short of a major Lottery win! - whereby they can repay the debt, then we’d recommend that they should seek independent professional advice with a view to approaching their lender bank to consider a Dación en Pago. We understand that their lender is not compelled to accept such a proposal but if the case is commercially good for the bank they are likely to consider it.

Should the above criteria not be satisfied it would seem that the solutions offered by a the Dación en Pago would be unavailable and faced with non-payment of their mortgage obligations the bank will be left with no viable alternative but to  institute formal repossession proceedings.

A defaulting borrower should note with concern that by the operation of the provisions of Article 1.911 of the SCC, that following the formal repossession of their property, the borrower will continue to be personally liable to the full extent of their worldwide assets for any excess owed to the bank – including all their professional fees and unpaid interest etc. – over and above the sums realised by the bank from the disposal of the property as a result of their repossession. This means that the bank may choose to explore the possibility of enforcing the balance of such a debt in a debtor’s home jurisdiction. Whilst seemingly unlikely given the commensurate costs if the volume of such debts increase the banks may be more than willing to consider this kind of strategy.  

The other side of the equation for the bank is if they agree to “write off” their debt by the use of the Dación en Pago procedure will they be able to find a subsequent purchaser in order to liquidate their “cash” out of the property?

The property will have become the banks and they will be registered as the new owner. Acquiring ownership will, of course, mean that the bank also assumes their former borrower’s responsibility for the “cuota” of the property – if on an urbanization – including the ongoing share of Community fees that run with such ownership.

The usual buying costs associated with a property purchase in Spain will equally apply to a Dación en Pago as for a usual sale and will need to be shouldered by the bank. These will include the usual Transfer Tax of 7%, Notary and Land Registry fees etc. and there will need to be further discussion with the bank in relation to Capital Gains Tax – if any - and the municipal Plus Valia which would usually be payable by the “seller”.

We suspect that those banks that are willing to consider such arrangements are keenly looking for an “end user” purchaser to take over the property from the bank. As a result, we believe that the banks will prefer to finalise their Dación en Pago arrangements with their debtor in tandem with the standard Compraventa paperwork once a “new” purchaser has been identified. This will in effect mean that the “new” purchaser settles the buying costs in the usual way.

To attract a “new” purchaser the banks seem, with some reluctance, to be starting to agree to discount their outstanding mortgage exposure on relevant properties in order to liquidate their position. This should mean that the “new” purchaser buys a materially discounted property that may well be priced at substantially below market value.

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