The Downturn… (cue ominous music)
It would be easy to label the decline of the Costa Rica real estate market (since the peak in 2007) in a negative light. In truth, there is no such thing as “negative light” only the opportunity for change, and if our market has seen anything over the past three years, it is change. The shift from bank loans to seller financing is one of the primary changes that has (pardon the pun) opened the door to prospective home buyers, as well as, land and commercial buyers.
Before defining the effects, basic models, and legal structure of seller financing, let me back up just a bit to clarify why we now find it present in about half of the Costa Rica real estate deals we facilitate. Like most lending institutions around the world, Costa Rican banks are better described as “institutional holders”. Banks are not lending for a few reasons— falling real property values, the recession, and they are not lending to each other (e.g., no credit to leverage). In Costa Rica, the debt-to-income ratio required to obtain a loan is as ridiculous as the double-digit interest rates being charged (often twice the rates in the United States). The banks’ parsimonious response has opened the door to seller financing, and Costa Rican property owners have embraced the new paradigm.
Sellers Get Creative
“What do I need to do to sell my property?” We received this common question too many times to count over the past few years. Our answer typically included these answers—
- list your property with an aggressive price
- keep the property or house clean and presentable
- offer seller financing
We have had a couple of recent sales with seller financing that fit the basic model—
- Price, parties agree to a sale price.
- Down Payment, buyer agrees to make initial payment, out of which, the seller pays commissions and closing costs.
- Financing Term, the number of years the mortgage or trust runs, with or without a pre-payment penalty, and with or without a ballon payment.
- Interest Rate, the % added to the balance due.
The main question sellers have is “What recourse do I have in the event of buyer default on payments or terms of the mortgage contract?” The answer is… it depends on whether the financing is set up with a mortgage or a trust.
“To Mortgage or To Trust… THAT is the Question”
As Eduardo Abarca Vargas, a reputable lawyer here in Uvita, explains, “Once the terms of the financing are agreed, there are two ways to set up the legal documents… in the form of a trust or a mortgage.”
About a year ago, he helped us clarify the basic differences between trusts and mortgages—
- Mortgage— The Borrower agrees to an encumbrance against a real property to the Lender, (e.g., first degree mortgage). A mortgage is filed to the Registry by the Notary Public in Costa Rica. Once it is processed by the Registry Officer, it is registered on the property and shown as a lien. In the event that the Borrower defaults, the Lender is entitled to enforce foreclosure. Then, the property goes to auction and the Lender is the first lien holder to be paid. If no person bids for the property, it is then returned to the Lender. This is the most popular financing tool used in Costa Rica. As Eduardo explains, “The most important reason to choose a mortgage as a guarantee is that, in November of 2007, the Costa Rican Congress approved a specific Law (Ley de Cobro Judicial # 8624) to enforce the mortgages before the Courts. This brought many advantages that the former law did not offer.”
- Trust— The secured Trust concept is as safe as a mortgage contract, but more complex in terms of documentation and set up. It can be more versatile and more economical than setting up a mortgage and with a simpler enforcement. The Trust Agreement identifies the parties and terms— schedule for payments, interests, penalties and a default provision— and issues an irrevocable stock power of attorney to the Trustee. The enforcement procedure of an eventual default scenario implies the simple sale of the property to a third buyer and the distribution of the proceeds. As Eduardo points out, “There is not an specific law to regulate the foreclosing process based on a Trust, therefore there is neither a Judge involved on the process nor any specific rules to foreclose.” This is the main reason most lenders are encouraged to set up mortgages instead of trusts.
Eduardo summarized the two options, “For the seller who wants the property to be returned to them in a timely manner, a mortgage serves the best purpose. It usually takes more time to execute a mortgage, but once the foreclosing process is done the lender will have a complete judicial file to support the transfer of the property.”
As recently as 2007, the majority of land and house deals completed in the southern Pacific zone of Costa Rica were done with cash. Since that time, we have seen a global recession. Most investors are not as liquid as they once were, and most banks are still not lending. The good news is… Costa Rica property values appear to be at the bottom, and seller financing has opened the door for home and land buyers.
To contact Eduardo Abarca Vargas– please call 2743-8345 or email him at email@example.com