Equity Release and Raising Capital on Real Estate in Spain
Updated 7th December 2005
There are schemes available whereby an individual can take out a mortgage (supposedly without capital repayments) against his/her property to reduce Spanish succession tax on death. The mortgage proceeds are then invested. We consider these arrangements potentially dangerous.
Unlike the UK, these mortgages are NOT real lifetime mortgages (if they were, we’d welcome the product). Unlike the UK you really can lose your home or the monies advanced, or both, in certain circumstances. So it could end in disaster, exactly as happened in the UK before they introduced true lifetime mortgages. If you were told otherwise by the salesman/adviser, you have no come back in Spain against mis-selling as the adviser is not regulated for advice over mortgages. So how can you lose your home? The products vary, but they will have one or more of the following risks:
(a) The loan is repayable after a certain time period, and the bank can simply recall the loan. This is more likely to happen at a time the value of your property has fallen, or if the bank’s management wish to pull out of all such loans. Of course, you’ll be assured this is highly unlikely, but they would say that, wouldn’t they?
And/or (b) You may be required to invest most of the monies into certain funds which are then made over as additional security to the lender, as well as the mortgage charge over your house. If the investments fall in value, or the currency moves against you, you may find that the lender sells your investments without any notice to you (but even if they were to give you notice, they don’t have to receive your agreement). In the UK schemes, the homeowner can apply the proceeds to anything he/she wants and not set aside into investments under the control of the lender.
And/or (c) If you skip any interest repayments the loan can be recalled. Some products now roll up the interest BUT that’s only for the first few years, not your lifetime. Interest rates may not be capped, and can increase at any time.
Schemes such as this were prevalent in the UK in the 1980’s and led to considerable mis-selling.
The mis-selling may arise because:-
(a) The financial adviser is keen to sell such schemes as it is an easy way to earn commission.
(b) The worst case scenario can happen and the longer the arrangement is set for, the more likely this might occur. That scenario (which happened in the UK in the late 1980’s) is:
(i) House prices fall
(ii) Interest rates rise, so the amount payable each year INCREASES.
(iii) Investment values and returns collapse, so you have less income to meet interest payments.
(iv) You can no longer afford to repay the interest on the mortgage and are forced to sell your home to repay the mortgage, sell your investments at a loss, and cannot now afford to buy another house of that value.
Spanish Succession Tax
The advantages which the lender’s broker puts forward are that you can reduce your Spanish inheritance tax. But this isn’t always true. In order to avoid succession tax using a mortgage, you must follow certain rules, and the broker/adviser often doesn’t bother to get this right:
For Spanish tax residents, by taking out a mortgage against your property, the mortgage will reduce your net assets in Spain. The loan proceeds must be invested outside of Spain AND either be in trust for your beneficiaries (who may include Spanish residents), or willed to non-Spanish residents. The Trust is a simpler method, and of course you can have Spanish residents as potential beneficiaries, and the settlor of the Trust (you) can remain a beneficiary as well.
For non-Spanish tax residents, the mortgage proceeds should be invested outside of Spain, and should not pass on your death to any Spanish tax residents.
Note that if you die a UK domicile, the mortgage does not save UK inheritance tax; it is a device only applicable to Spanish succession tax, though it may reduce the tax in Spain on the death of the first spouse.
What happens if someone wishes to sell their property?
In the event of someone wishing to sell their property (for whatever reason) the loan would need to be repaid. The loan is therefore not transferable from “property to property”, which is a feature of a true lifetime mortgage as available against UK properties.
Some schemes invest the money with a fund which offers a guarantee on capital. This guarantee means that it will pay back a minimum of the original capital after, say, a 10 year period. So, if you invest say €500,000, this being 75% of the value of your property, then you are guaranteed to get this back as a minimum after 10 years. However, lets look at a scenario whereby the fund does not grow at all over this period of time, you would get back €500,000 (assuming the guarantee is met) but you would have run up interest payments on the loan taken against the property. Let’s say at 4% interest only, compounded monthly, the interest amounts to a total of 50% i.e. another €250,000 on top of the original loan.
On the other side it may make money and cover the costs of the loan which is what it is intended to do along with alleviating Spanish IHT. However guaranteed investments can struggle to perform well over such a long period.
Will the loan be deductible for Spanish Succession Tax (“SST”)?
Simply having a charge against a Spanish property may be inadequate since SST precludes the deduction of a mortgage against Spanish real estate in arriving at the market value of the property liable to SST.
However, a non binding tax ruling (dated 13 November 2002) allows Spanish situated debts to be deductible against SST, but it doesn’t define “Spanish situated”. Article 1171 of the Spanish Civil Code states that where principal and interest are payable in Spain then the debt is likely to be Spanish situated. To prove this, it is advisable that the loan agreement not only says it’s repayable in Spain, but that the leader has a bank account there to receive all repayments.
If you are wealthy and have a definite short life expectancy, and your life style wouldn’t be affected even if both house prices and investments fell in value, then a scheme correctly implemented would be suitable, as it can reduce your Spanish succession tax