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Perils of Equity Release Schemes

Equity Release in Spain

Is This The Next Financial Mis-selling Scandal?

 

by Bill Blevins, Financial Correspondent

Blevins Franks International

 

 

A number of schemes are currently being aggressively marketed in Spain suggesting that you may be able to release the equity in your property for reinvestment, improving your income and saving tax.  

 

On close investigation I have discovered that, at this time, there are inadequate regulatory and other safeguards for such schemes to be recommended to property owners in Spain.

 

Unless you fully understand all the small print, you could end up losing your home. 

 

The market for such schemes is ripe in Spain and many property owners are hugely “over housed” and “under capitalised” following the price rises in recent times.  Therein lies the temptation to get into “arrangements” designed to release the equity in the property. 

Commonly, marketing literature devotes a lot of space to the benefits and very little to the risks.

 

Equity release schemes in Spain allow a property owner to take out a mortgage, normally without capital repayments, against the security of his or her property.  Provided the borrowed funds are properly reinvested outside of Spain, this is likely to reduce Spanish succession tax on death.    The loan can be as much as 100% of the property valuation for suitable applicants, and most lenders will agree the loan in most leading currencies, although the interest rate will vary according to the currency chosen.  The lender may allow some of the loan monies to be utilised as you wish, but will require most of it to be invested and offered as further security for the loan. 

 

A typical loan is for a five year period, after which it would have to be re-negotiated.  The lender may not be obliged to renew and may demand repayment at the end of the original loan period.

 

To avoid succession tax in this way you must follow all the rules.    If you are a Spanish tax resident, the mortgage will reduce your net assets in Spain.  Of course, the loan proceeds must be invested outside Spain, either via a Trust for your beneficiaries or in a Will to non-Spanish residents.  If you are not a Spanish tax resident, the mortgage proceeds must be invested outside Spain and should not pass to any Spanish residents on death.  

 

This equity release process only aims to reduce Spanish succession tax; if you are a UK domicile when you die these schemes will not reduce your UK inheritance tax liability.    

 

This scheme is not suitable for you unless your estate has a real exposure to Spanish succession tax and you are prepared to accept all the risks that go with such schemes.

 

The risks:

 

·        If you do not pay the interest on time, your house is at risk.   Some lenders retain the right to sell your property to repay their loans without prior notice.

 

·        If your property falls in value, you may be asked to provide additional security or repay part or the whole of the loan. 

 

·        The investment of the loan proceeds may fall in value and may provide less income than interest being charged on the loan.  In some cases when the investments fall in value the lender has the right to call in the loan if the investments do not then provide adequate security for the amount borrowed.

 

·        If the loan currency is different to the investment currency, foreign exchange movements may result in the investment being less than the value of the loan. 

 

·        The loan may be called in after five years and you may be forced to sell your property into a depressed market to meet repayment.

 

·        The loans are not normally transferable from property to property. If you wish to sell your property you will need to repay the loan. 

 

·        If you decide to repay your loan early, depending on the type of mortgage you have, you may have to pay penalties or charges.   

 

·        There are no regulatory safeguards under Spanish law to protect the investor from mis-selling.

 

Equity release schemes are available in the UK, but do not presume the schemes in Spain are similar.   In the UK normally no interest payments are due, whereas in Spain the borrower is normally required to pay interest.  Secondly, capital repayments are not normal in the UK.  With most lenders in Spain, the loan can be recalled at any time after five years (or sooner if interest payments have not been kept up).  Importantly, in the UK various regulatory safeguards are now in place to protect the investor from mis-selling – this is NOT the case in Spain.   Finally, UK schemes allow you to spend the proceeds as you wish, and do not require you to invest most of it.   In summary, UK schemes do not normally risk you losing your home, but under the arrangements I have investigated which are available in Spain, your home IS at risk!

 

In the 1980s, schemes similar to the Spanish ones were prevalent in the UK and led to a substantial amount of mis-selling.   The mis-selling potential arose because in the late 1980s:  house prices fell; interest rates rose (so the amount payable each year increased); investment values and returns fell (so investors had less income to meet interest payments).   Investors who could no longer afford to repay the interest on the mortgage were forced to sell their homes to repay the mortgage – and could not afford to buy another house of a similar value.     

 

Succession tax

 

The major benefit being promoted for these schemes in Spain is the reduction of Spanish succession tax.  Check out your potential liability before proceeding with such schemes. 

 

Spanish succession tax is governed by the Autonomous Communities (Regions).  There is a growing trend towards the abolition of Spanish succession tax in direct line and between spouses.

 

In the Basque Country, spouses and direct line descendants have been exempt since 1993.  Andalucia is taking steps to eliminate the tax, announcing in September 2003 that it would abolish this tax in this Region from 2004 for beneficiaries resident in Andalucia on inheritances of less than €500,000.  In the Balearics and Valenciana (covering the Costa Blanca) the ruling Partido Popular are considering similar steps.

 

If you are considering an equity release scheme, I strongly suggest you ask an independent financial and tax adviser to establish exactly what your Spanish succession tax liability is and whether the scheme recommended is actually the best idea for you.   Also, ask them to run through all the small print with you and explain the technical aspects, the risks and what the worst-case-scenario would be.   It is vitally important to weigh up all the risks to ensure the scheme is suitable for your financial situation. 

 

If you do decide to go ahead, then make sure the scheme is set up in the best possible way for you. For example, you need to establish what sort of Trust to use and what investments to make.

 

When it comes to something as important as your future security, you should never judge a book by its cover.  And finally, once again, always remember, if it sounds too good to be true… it probably is.

 

 

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