As explained in previous articles on Bank Repossessions in Spain, the responsibility of a borrower on defaulting a loan is personal and unlimited in Spain. Frequently, post-repossession, a borrower will still owe capital which increases exponentially over time due to the compound interests and associated repossession expenses creating a debt spiral which acts as a black hole.
By Raymundo Larraín Nesbitt
Lawyer – Abogado
8th of March 2012
In the above article from 2007 I already offered as an alternative solution to borrowers to pursue what is known as a “dación en pago” (handing back ther keys to a lender); a solution of last resort. A dación en pago allows a borrower to legally hand back the keys and in exchange a lender fully discharges the borrower of the debt. This is formalised before a Notary public by means of a deed whereby property ownership is relinquished in favour of a lender. In this manner, speaking of foreigners, the lender would be unable to pursue you abroad for the outstanding – mounting –debt considering it settled for good. It is akin to placing a legal firewall to avoid jeopardising your home country’s assets.
The dación en pago was an option lenders welcomed back in the early days of the recession – particularly in the case of foreign borrowers – as they normally held no other assets in Spain and pursuing them abroad for the shortfall – although legally possible – was normally a fairly complex and expensive procedure not making it worth their while from a financial point of view. Being pragmatic, it made more sense to accept a dación rather than follow a protracted and winding repossession. Back then lenders demanded properties be in positive equity to accept a dación en pago. As the recession unfolded, giving way to the most important one the world has known since the Great Depression, lenders grew more and more reluctant to accept a dación en pago proposal (as they themselves struggled to secure finance from abroad) to the point this window of opportunity was eventually shut off, even if the property was in positive equity territory.
This procedure is loosely based on art 1.175 of the Spanish Civil Code and article 140 of Spain’s Mortgage Act. There is no article in our legal system which actually enshrines the dación en pago procedure. This is the reason why I always wrote that a dación en pago was not a borrowers’ divine right, despite claims to the opposite by self-appointed qualified online experts. Rather, it was a voluntary agreement reached with a lender (because they actually stand to lose a great deal on accepting it). That is why they insisted as a pre-requisite the property be in positive equity for them to even consider studying a dación to offset their losses on taking over the property. It was really up to them to either accept or decline the proposal; it was pointless to challenge their refusal throwing good money after bad, even more so if the property was in negative equity.
The Government’s concern has grown deeper as the recession in Spain has gathered pace since 2007 with thousands of families in its wake being repossessed every year and still owing significant amounts of capital they will never be able to repay back to their lenders. Lenders know it all too well and sell off these bad debts in tranches for a fraction of their book value to specialised institutional investors and debt-recovering companies. This disturbing trend has continued unabated in 2012. This has created serious social problems as hundreds of thousands of families are effectively evicted and locked out of the financial system with no hope of obtaining a loan as they are viewed as financial pariahs by our so-called modern society.
The Spanish Government has finally reacted in 2012, some five years after the recession began, publishing a non-binding Code of Practice for lenders to adopt the dación en pago procedure following a major social outcry which was echoed in Congress. This episode has witnessed some embarrassing moments of its own, such as the intervention of Ecuador’s president advocating the dación in favour of its struggling countrymen facing looming repossessions in Spain. However, if lenders should choose to formally adopt the Government’s proposal, it becomes compulsory for them, being forced to accept a dación.
The catch, as always, is that a borrower must fulfil stringent criteria to qualify for it which – in practice – leaves out most foreigners. Speaking clearly this means the Code of Practice introduced by the Government will benefit foremost nationals and lock out most struggling foreign property owners as one of the requirements is that the Spanish property must be your only asset; excluding those borrowers who hold property abroad i.e. in their home country.
They are blatant. You can now walk away from the threat of a looming repossession procedure safe in the knowledge that your lender has signed a legally binding deed before a Notary in which they forfeit taking legal action against you for the outstanding debt. The peace of mind this has given my clients is simply priceless and cannot be understated enough.
The generalised adoption of a dación en pago procedure will make banks think twice before they lend money. This will enable that hundreds of thousands of families are once again recovered for society at large allowing them to move on with their lives starting anew rather than sentencing them for the remainder of their lives as financial zombies. Everyone deserves a second chance in life.
As a result lenders will now strive to protect themselves as these newly-introduced measures effectively break a long-standing status quo lasting for over a century.
I can foresee lenders adopting the following measures to counter their real estate losses as a consequence of generalising a dación en pago procedure:
– Credit restriction. Lenders will foreseeably tighten their criteria when it comes to lending for property-related purchases. Only those families which are deemed financially capable of repaying their loan will have access to credit. Up until the recession began, mortgage loans were handed out recklessly to anyone with a pulse. This has backfired spectacularly over time on financial entities, particularly on savings banks which had lenient standards to put it mildly, as it was entirely predictable. Seeking short-term gains, losing sight of the long-term business viability, brings these debt-laden problems.
– Credit will become more expensive. Meaning the rate charged to certain borrowers will be increased as a result to offset – repayment – risks.
– Additional guarantees/collateral requested i.e. family assets, personal guarantors (i.e. family members that guarantee a mortgage loan with their own properties etc. As a side note, I always advice everyone to never accept being appointed as a personal guarantor, even if it is for a family member or a friend, as you stand to lose your own property if they default on their mortgage loan. It is very foolish.
Bank shareholders and stakeholders have good reasons to be weary of these measures introduced by the Government as they will potentially incur in heavy losses. Being cynical I guess it will eventually be the taxpayer – you and me – who will pick up the tab after all.
Code of Good Practice
Was approved on the 9th of March and is compulsory for all those lenders who voluntarily adhere to it. It introduces three very interesting measures.
1. Debt restructuring. Before a dacion is even contemplated – providing you fulfil the below requirements set out in point three – a lender will first strive to restructure the debt. Amongst the measures introduced are:
– 4 years of interest-only (“carencia”)
– Extending mortgage repayments up to 40 years
– Reducing the applicable interest rate to Euribor plus 0.25
2. Debt reduction. Failing the above, the lender will then be forced to bite the bullet and write-off part of the debt burden to make repayment terms more manageable for the borrower. At this point the lender will be incurring in losses for the first time. The threshold is that repayments must be below 60pc of the family’s monthly income.
3. Dación en pago. Only if the two previous points fail, will a lender then consider following a dación en pago as the last resort. Lenders will incur in heavy losses on accepting it, which is why this option is only considered if there is no other one available to them. More details on this can be found in my article Dación en Pago Explained, from 2009.
To benefit from a dación en pago a borrower must comply with the following five points:
– Failed the above two points: debt restructuring and debt reduction plans. Post-restructuring, repayments that still exceed 60pc of the family’s monthly income will qualify for a dación.
– The value of the property, following a sliding scale, must be below €200,000 in large cities, such as Madrid, and below €120,000 for towns with less than 100,000 citizens.
– The property must the borrower’s only home (in Spain or elsewhere).
– All family members must be jobless (in Spain over 1,5mn families comply with this).
– No one acting as guarantor.
At the time of writing this article, 95pc of Spanish lenders have adhered to this Code of Practice. A list of all those lenders which have voluntarily accepted it will be published before the 10th of April.
The generalisation and adoption of the dación en pago procedure, now finally a borrowers’ right, is a welcome respite for struggling borrowers. However, as I’ve pointed out, these new measures will benefit Spanish nationals foremost for a number of reasons.
More could be done to generalise it so that even more borrowers were eligible making it truly an option open to everyone that needs it. A compromise had to be reached at some point with lenders and the above five requirements were decided as the cut-off point. In any case, it is a positive first step in the right direction and thousands of families will now stand a second chance in life as a result of it.
If you are unsure on whether you may qualify for a dación en pago, seek legal advice.
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