2008 Butterworths Journal of International Banking and Financial Law, n.º 1
The recent enactment of Spanish Law 41/2007 resulted in an important and long desired reform of the Spanish real estate credit market.
The importance of the real estate credit market for the local economy is apparent in consideration of the fact that housing financing amounts to two thirds of the total wealth of Spanish families and that mortgaged collateralised loans exceed half the total credit granted to private sector resident in Spain.
Along with the modernisation of the Spanish credit and mortgage legal regulations, the stated purpose of Law 41/2007 is the creation of new legal institutions that, while providing new market opportunities to financial entities, are also useful to address customers’ needs. The average age of the Spanish population has continued to increase, the doubts have increased for the capacity of the social security and public pension system to maintain their payment obligations. Furthermore, while statistics differ, at least 80% of people over the age of 65 reside in a real estate property which they themselves own and that are, in general, free from liens, mortgages and encumbrances. Lastly, but of importance is the fact that Spanish pensions received by retirees are in most instances lower in comparison with other European countries.
These demographic and cultural features of the Spanish market have created significant opportunities for financial entities. Yet, these characteristics of Spanish real estate owners are not the only reason why it has been suggested that reverse mortgages will thrive in Spain. In a country regarded as a world class retirement destination where currently 2 million (out of 23 million) real estate properties are owned by foreigners, the market potential for both local and foreign credit entities is obvious.
Prior to the enactment of Law 41/2007, a number of savings banks spotted the opportunity and executed reverse mortgages. The result was insubstantial, not because reverse mortgages were legally prohibited but rather because the costs as well as other barriers associated with them, that have been addressed by Law 41/2007.
Under Law 41/2007, a reverse mortgage or lifetime mortgage has two distinct characteristics that distinguish it from any other type of mortgage normally granted by Spanish financial entities.
First, reverse mortgages are intended to release equity in a residence as one lump sum or in multiple payments. The payments due in a reverse mortgage may adopt the form of an ordinary annuity (a stream of fixed payments over a specified period of time) or a lifetime annuity (a stream of payments during the homeowner’s life, or during the lifetime of the last surviving beneficiary, where applicable).
Second, the debtor's obligation to repay the loan is deferred until the owner dies or the home is sold. In a typical mortgage, the homeowner is charged with making monthly payments to a credit institution. The equity increases within his or her property after each payment and typically after the end of the term the mortgage has been paid in full and the property is released from the lender. In a reverse mortgage, the homeowner makes no payments and all interests are added to the lien on the property. If the owner receives monthly payments the debt on the property increases monthly.
THE SPANISH LEGAL FRAMEWORK
To qualify as a reverse mortgage, a mortgage should comply with the following requirements:
- The reverse mortgage should be granted over the continuous residence (vivienda habitual) of the debtor. Nevertheless, reverse mortgages may also be granted over real estate assets other than the debtor’s home provided that the reduction in notary and registration fees and the stamp tax do not apply (see Costs and Expenses below).
- The debtor (and where applicable, the beneficiaries) must be at least 65 years of age or older or otherwise be under severe or elevated economic dependence (as defined by Spanish regulations);
- The debtor may receive the proceeds under the loan as a lump sum or in several instalments. Although Law 41/2007 does not address the issue, theoretically there should be no difficulty for an agreement on an initial sum and an annuity;
- The debt must not be callable by the creditor and the mortgage must not be enforceable until the death of the debtor or of the last surviving beneficiary; and
- The real estate property must have been appraised and properly insured.
There are no restrictions to the type of person that may be granted a reverse mortgage or to the licenses that a person must hold in order to grant a reverse mortgage. However, to qualify for the special benefits set out in Law 41/2007 (i.e., the reductions of costs and taxes) the reverse mortgage must be granted by a credit or insurance entity authorised to carry out the activities in Spain.
The requirements to market reverse mortgages, including transparency obligations, are subject to implementation by the Ministry of Economy. Regarding transparency, when entering into a reverse mortgage financial entities and insurance companies are required to provide their clients with independent advice, especially in connection with the financial situation of the applicant and the economic risks of reverse mortgages. The form of this advice as well as its conditions and requisites shall be determined by the implementing regulations of Law 41/2007.
Transfer and cancellation
If the mortgaged asset is voluntarily transferred by the debtor before his or her death, the creditor must declare the early termination of the loan unless the mortgage is substituted by an analogous guarantee. Law 41/2007 does not set forth the criteria to determine which guarantees may be considered analogous to the reverse mortgage, in particular if these guarantees may be, apart from mortgages over other real estate assets, liens over movable assets. It appears that bank and other personal guarantees are not included in this category.
Upon the death of the debtor (or, where applicable, of the last surviving beneficiary) his or her heirs will be entitled to cancel the loan by paying the creditor the outstanding principal and all interests accrued. Prepayment fees are not permitted under Law 41/2007.
If the debtor’s heirs decide not to pay the outstanding debt (i.e., the principal and interests), the creditor’s only recourse will be against the inherited assets and not on the heirs personal assets. This is an exception to the general principle that a creditor may seek payment for its credits by foreclosing on the personal assets of the debtor’s heirs unless the inheritance is accepted under “benefit of inventory” (beneficio de inventario).
Tax and expenses
As regards costs and taxes, reverse mortgages have two positive characteristics:
- First, reverse mortgages qualify for a reduction in the notarial and registration fees. The reduction applies not only to the creation of the mortgage but also to the execution and registration of amendment, subrogation and cancellation deeds. It must be noted that, under Spanish law, mortgages are only valid if formalised in a public deed and registered with the relevant land registry. As such, the impact of this reduction on the total costs of the reverse mortgage is significant.
- Second, reverse mortgages qualify for a reduction of the stamp tax (impuesto sobre actos jurídicos documentados) applied to the creation, amendment, subrogation and cancellation mortgage deeds (in general. 1% of the amount secured by the mortgage).
From an income tax perspective, the proceeds obtained by the debtor through the reverse mortgage are considered as debt as opposed to income and therefore not subject to personal income tax.
Also, the proceeds obtained by the debtor by virtue of the reverse mortgage may be totally or partially applied to an insured pension plan in favour of the debtor. In this event, the survival of the beneficiary for a period of ten years or more is equivalent to his or her retirement for the purposes of the functioning of the pension plan.
Whether the reverse mortgage will or will not be used in practice depends not only on its economic benefits (i.e., costs, taxes, etc) but also on associated sociological issues., In Spain, the traditional opinion has been that descendents should receive the majority of their parents’ assets upon their death. This thought is reflected in the Spanish Civil Code in the so-called legítimas: restrictions to the autonomy of parents to dispose of significant portions of their assets in favour of persons other than their descendents. It has been said that legítimas belong to an older society in which the descendents contributed with their work to the family’s wealth and it was therefore reasonable that they expected to receive a portion of that wealth upon their parents’ deaths. As such, the legal system protected this expectation. More and more individuals are in favour of modifying this system, but to date it has not yet been changed.
Although the reverse mortgage does not contradict the legítimas system (the legítimas system prevents a person from giving his or her assets to people other than the descendents but not from expending, consuming or selling the assets), the legítimas reflects a mentality that has not yet been eliminated: the notion that parents must save all their assets in order to transfer them to their descendents. In connection to this, it is somehow desired by a significant stake of homeowners that their home is inherited by their descendents. Although in recent decades the mentality of the Spanish people has changed significantly, this preference is deeply-rooted (and mainly in elderly people) which may hinder the popularity of reverse mortgages in coming years.
To conclude, it is too early to assess the impact of the new regulation on the mortgage market and whether or not it will overcome the traditional difficulties surrounding this type of financial product. Also, some important parts of the legal regime such as transparency requisites are yet to be defined by the implementing regulations. However, the launch of the reverse mortgage appears to be an opportunity for the diversification of the mortgage market in Spain and the release of the home equity of seniors.