Primer
Mexico Mortgage Financing Primer
June 2009
By Paul Montry
This article is intended to educate foreign nationals, namely Americans and Canadians, interested in obtaining a home mortgage in Mexico with Mexican residential real estate as collateral. It describes key differences in international lending in Mexico relative to the United States, and specifically details:
- Rates and Terms
- Requirements
- Loan Costs
- Process
- Timing
- Recommendations
To begin with, it is important to understand that the mortgage lending market in Mexico is in its infancy. With a longstanding and stable Mexican economy, competitive offerings from multinational lenders began in earnest in 2005. Competition and consistent lending terms have created standards in mortgage lending in Mexico recently, however, the process remains complex and lengthy in a relative sense. One should anticipate 45-60 days for loan funding upon submission of all required documentation.
The recent availability for foreigners to mortgage real estate in Mexico is an advantage that provides flexibility in leveraging international holdings and an improved investment return potential. For Americans, interest remains deductible under the same U.S. tax policy and regulations.
Much of the following may seem complicated, but the requirements are similar to the U.S., and exist to establish the legalities and protect ownership and rights. The importance of engaging an experienced professional broker as a borrower’s advocate should be clear from the ensuing detail.
Rates and Terms:
As with any mortgage loan product, among other risk factors, rates vary largely according to credit score and duration of the loan period. Rates mentioned here consider a high quality credit score of 700+. Rates are typically 1-2 points higher relative to a jumbo second home mortgage rate in the U.S. with the obvious rationale that the banks require higher returns for the international lending risk.
Loans with fixed rates, adjustable rates, and shorter amortization are commonly placed. As of the date of this article a benchmark 30 year fixed rate loan on property in Mexico is 8.99%. Contrasted toward the other end of the spectrum, a 15 year loan amortization term with 3 years fixed (remaining years adjustable at Libor+) can be obtained at 6.75%.
Loans are most often denominated in U.S. dollars, but peso loans are also available, although at higher interest rates. Lending rates in Mexico don’t fluctuate in the same way as they do in the U.S. When entering the Mexican market, which is no simple task, lenders set their rates and unless global interest rates change dramatically their product offerings generally remain the same. Frankly, they aren’t faced with the same volume of competition and have established their products to be profitable within a broad change in interest rates.
It is also important to mention that nearly all loans have a prepayment penalty during the first 3 years, a 3-2-1, which declines from 3% in year one to 2% in year 2, and 1% in year 3 before expiring altogether. The reason for this clause is that lenders have calculated a required return on the loan based upon a minimum servicing period to compensate for originating it.
Loan options in Mexico are not as plentiful and creative as in the U.S. Currently there are no “interest only” loans available, nor are there approved “credit lines” available to draw against. However, most standard terms are available and offer a desirable range to achieve various objectives. It is not as economical to borrow against Mexican real estate as it is against U.S. property, but the availability to leverage assets in Mexico is a significant development and capability in a market that required “ all cash” until recently.
Requirements:
Trust
A significant difference an American will encounter buying property in Mexico is a Trust. If you’re investigating financing here in Mexico, you’re likely already aware that for foreigners to acquire property within 30 miles of the coastline and 60 miles from the border requires a property trust (in Spanish a Fideicomiso.) Terms are 50 years with the ability to extend for an additional 50 years. The cost is usually between $500-800 per year maintenance fee paid to a local bank. The trustee (bank) has no ownership in the property. Foreign nationals are entitled to all rights and privileges including use and enjoyment, profits, and the ability to transfer ownership for estate planning, etc. Similar to a U.S. loan structure, security is provided to the lender by means of a first lien position for the outstanding amount of the loan, but in this case that security is in trust.
Without going into all of the detail surrounding a Fideicomiso, a simple perspective of the reasoning behind this requirement is that a national bank acting as trustee ensures conformity to Mexican law. This landmark legal structure allows foreign investment in residential property, and has spurred significant growth since it’s passage in 1994. The terms for the trust are negotiable, and it is important that a buyer takes time to understand the specifics. This area in particular requires diligence in assuring that the buyer’s interests are properly represented, and legal counsel is required.
Credit
· Credit score minimum – 680
· Loan to Value maximum – 70%
· Debt as % of income maximum – 40%
· 2 years tax returns with application
Lending qualification requirements for the borrower are more stringent than those in the U.S. This approach has helped avoid the sub-prime calamity in Mexico that has created such global credit concern. Lenders expect credit scores to remain above 680 during the loan approval process, with preferred rates for scores above 700. Additionally, nearly all lenders require that no more than 40% of income can be committed to debt service to qualify. These days, effectively all loans require full documentation, including submitting the last two years of tax returns with the application. Passport and proof of U.S. residence is also required. It is recommended to obtain a Mexican visa (FM3) that permits opening a local bank account, importation of an automobile, and stays beyond tourist timeframes.
Notary
A notary will be involved in any property transaction in Mexico and serves a critical role in the transfer and recording of title. It is important to note that Notarios are not an advocate for either buyer or seller, but act as a transaction attorney to ensure legal compliance. Their function is similar to that of a title agent in the U.S. wherein they make certain that all of the specifics regarding the title transfer of property, including sales price, taxes, etc. are recorded properly in the national land registry. The fees associated with this service are not insignificant and are negotiable.
Process:
Timeframe from application to funding of the loan is considerably longer than we are accustomed to in the U.S. and a borrower should expect 6-8 weeks for funding. The process involves numerous different parties including a Notario to review, opine to the accuracy, and ultimately record the title (Escritura), an Attorney to draft the Trust document, and a Trust bank (different from the lender) that will act as the Trustee agent ensuring compliance with Mexican law per above. It is also likely that Title insurance will be required which adds to the process and timeframe, though some banks are satisfied that the Notario opinion is adequate title security.
When put into context of involving all of these parties, in addition to the buyer and seller, who must come to terms and face their own requirements to provide information, the importance of coordination should be clear. There are many occasions for delay, and particularly so here in Mexico.
Managing the process and coordinating the cooperation of all of these parties is in no small measure where a mortgage broker earns a professional fee. Relationships and on the ground presence are extremely important in expediting this process, avoiding delays, and moving a loan to closing.
Loan Costs:
Most loans involve costs in the 2-3 point range. As in the U.S., some lenders charge higher points upfront (buy downs) with lower interest rates, or conversely, lower points upfront with higher rates. The decision on which terms to choose depends on the borrower’s objective, i.e. monthly payment amounts, how much of a loan is required, how long they intend to keep the property, etc. Title insurance is required by most lenders, and is usually in the ¾ point range. In addition, a U.S. style appraisal is required and will approximate $800-1,000.
The fees described above should be the only additional fees of consequence associated with a mortgage loan in Mexico. It is important to be clear that the title transfer fees described below will be incurred irrespective of a loan or cash purchase.
Other expense such as Title Transfer Tax of approximately 2-2.5%, Notary Fees of approximately 1.5-2%, government permits and registration fees, trust formation and first year management fee, escrow fees, etc. will be incurred on a cash transaction independent of a loan. Lenders and brokers have established relationships that can result in reduced fees, particularly for Notario and attorney services.
In summary, total Closing Costs for a property acquisition without a loan will be in the 5-7% range. Adding loan costs to a property purchase will bring the total closing costs to 7-10%. A borrower should insist on a good faith estimate up front.
For an informative comparison and example of closing costs, detailing both costs with versus costs without a loan, please reference the website listed at the end of this article.
Timing – Occupancy versus Title Transfer & Loan Funding:
Another key point, which frequently adds to frustration when expectations are not properly set, is that lenders will not fund until the title (Escritura) is ready and can be transferred. Often times new development property is being conveyed to an owner via contract for a “pre-construction” condo. A typical construction contract will call for payments being made during the construction process with final amounts due at the acceptance “punch list stage” or “occupancy.”
Occupancy and Title are two very different things in Mexico. When a unit is fully paid for the buyer “owns” the property and is allowed to occupy. However, and particularly in new multi family construction, the “owner” is likely not to have title for a considerable period of time. It is not uncommon for one full year to pass, post delivery, before officially receiving title in a new construction project.
Obviously, if the legal obligations (payments) have been met, “ownership” resides with the buyer, but the official recording of the property deed may remain ”in process” for quite some time. By way of explanation for what is an extraordinary delay, new condominium development projects must be regularized for recording via a Condominium Regime (complete legal description, specs, etc.) which is required by the Notary to officially record the deed in public registry. This legal detail is a lengthy procedure to complete. For obvious reasons, lenders will not fund a loan until the deed is in place with the lending bank in first lien position on the title. Otherwise, the bank has no security interest for collateral. For this reason alone, a loan serves to protect investment interest by ensuring that all of the legal procedures have been met in connection with funding.
Recommendations:
Below are a few recommendations to consider in new purchase contracts that facilitate financing flexibility and offer general investment security protection for acquiring property in Mexico. While some may seem to impose potential impediments to a deal, in this author’s experience, these provisions proved to be not only helpful, but essential.
· Negotiate a financing contingency clause in new purchase contracts.
· Insist upon investment security through means of a “get out clause” for unexpected delays on pre- construction.
· Request upfront closing costs and good faith estimates for financing.
A common issue mortgage brokers frequently encounter is the expectation that a loan can be put in place immediately when the unit is completed (at occupancy and before the title transfer timeframe as described above). Americans are used to a simultaneous transfer at the closing table, usually at a title company office, where we settle all payments and execute the transfer with signatures of all parties. For reasons previously expressed, this process is not so simple in Mexico.
To more fully describe this situation consider the following: a buyer has signed a contract for a residence under construction and has agreed to scheduled payments culminating in final amounts at “acceptance of delivery” and occupancy. Usually, at or near delivery a borrower inquires as to obtaining a loan. If there is a pressing need for funds to close, the timing is already too late. While there is the option of an equity loan or ”cash out” post closing, many lenders only have products for the initial contract purchase. The equity loan options are limited in the current environment, and additional expense is required post the initial close to put a loan in place.
Therefore, a recommendation for anyone considering a purchase (at contract stage) is to put in a clause that allows for final amounts to be paid in connection with the title transfer – even if that means delaying occupancy. In the current buyers market, negotiating this point with developers should be easier. Without this clause, terms usually call for payment in full at completion.
While not intended to cause undue concern, there are instances when construction projects, especially those dependent upon pre-sales, are significantly delayed. This potential situation should be of concern for any buyer, particularly in this market climate. If monies are paid in during construction without any specific obligation to refund if delays exceed a date certain, the buyer has little recourse. Furthermore, if at all possible, it is most preferable to have a cancellation clause with a guarantee that secures repayment in the instance project delays exceed a reasonable timeframe.
Finally, buyers should request estimates for closing costs up front. Individuals new to buying property in Mexico are often surprised at the cost associated with closing and transferring title which, as mentioned, is 5-7% of value. Much of this surprise is related to the transfer tax (~2.5%) and other governmentally required service and transaction fees which add up and are expensive relative to the U.S. A word about the transfer tax, which is set by state regulation: ongoing annual residential property taxes in Mexico are nominal, which is supported by assessing a much larger tax at the time of transfer. Put in perspective relative to the U.S., this tax is the equivalent of a number of years of real estate tax paid upfront. Upon consideration of a long term holding period, this tax policy serves as a positive. Overall, it is obviously important to anticipate all of the costs in connection with the planning of an initial purchase.
Conclusion:
While not without challenges, new borrowing options for foreigners acquiring Mexican real estate have created additional demand from new buyers able to access leverage. Ultimately, good basic lending practices will assist in creating demand for real estate, support valuation, and continue to contribute to economic expansion in Mexico.
It should be clear from the foregoing that mortgage financing in Mexico is not as simple, quick or easy of a process to which Americans are accustomed or might expect. And the detail, nuances and subtleties of acquiring real estate with financing are best handled through professional service. There exists a demonstrable value in employing a broker experienced in placing mortgages in Mexico who not only provides the essential financing service, but serves as an advocate in protecting client interests.
About the author of this article
Paul Montry is an investment manager with 20+ years of broad finance background and transactional experience. A resident of Puerto Vallarta, he is a licensed and authorized mortgage broker in the U.S. and Mexico, and has provided financing solutions in Mexico since 2006.
For further information, please visit www.MortgageforMexico.com or call 303-731-3636 in the U.S. or 322-209-0692 in Mexico.