Cross-Border Financing In Mexico

Cross-Border Financing In Mexico
By Doug Jones – June 2006

When purchasing property in Mexico, the name of the game has been “cash only” - that is until recently. Today, there are financing options available in Mexico to Foreign Nationals (non-Mexican Nationals) that can closely resemble options you may be used to seeing in the United States and Canada. These loans are known as “Cross-Border” loans, which means the loan is being made in the United States, and the loan is being secured by real estate located in Mexico.

The same mortgage broker model you are used to in the US and Canada is developing in Mexico as well. As more sources of money become available, these lending sources will be looking for qualified, established brokers to represent and originate loans for them. Mortgage brokers have multiple loan programs from many lending sources to help the borrower sift through the different requirements each of these lending sources has. By asking questions about what you want to accomplish, a mortgage broker will be able to present you with the available loan program options and assist you in making the best decision to match your needs. Lending programs and requirements are changing quite rapidly.

Historically, there have been several obstacles for lenders to overcome in order to lend in Mexico. The first and foremost matter in a lender’s mind is if payments are not made in a timely fashion, what recourse is there? In the US, a lender has a specific foreclosure procedure that is spelled out in advance and is recognized without having to go through the US Court system. In the past, this has been a difficult task to accomplish in Mexico. In fact, foreclosure proceedings have had to go through the Mexican Judicial system, which at best is a risky and expensive action for a lender. There was no assurance as to how the Mexican courts would decide, which is a scary proposition for a lender who has thousands of dollars outstanding on a property. The lender wants to be assured that if there is a default in payments, the lender can take back the property and dispose of it to re-pay their loan.

At the heart of this is the matter of how title is taken in Mexico. With the advent of title insurance in Mexico (Security Title and First American Title), this has taken away potential problems with a clear title being available on Mexico properties. This has also provided peace-of-mind to foreign buyers in Mexico. In the restricted zone (100 km from the border and 50 km from the beach), Foreign Nationals must obtain property either through a Mexican Corporation, or a Fideicomiso (bank trust). In my experience, lenders will not make a loan on a property that is taken in title by a Mexican Corporation. Under a Mexican Corporation, the advantages to the buyer are disadvantages to a lender. If you are planning on getting a loan, you may want to re-think this as a viable option. This is especially true of people who purchase an individual lot and want to build on it later. If you purchase the lot through a Mexican Corporation, it is doubtful you will be able to get a loan to build your home. You are better off purchasing your lot with a standard Fideicomiso and then putting a loan on the property before, during, or after your home is built. Lenders are comfortable with their foreclosure options in Mexico and are therefore willing to make loans South of the Border.

Another risk for a lender to make loans in Mexico has been the matter of the peso-devaluation. There is a 30 year history of the peso (MXP) devaluation to the USDollar (USD), and the average has been in the neighborhood of 6% per year. When a lender is assessing the risk involved in making a loan, they have had to look at this devaluation and add it on to the yield they require to make a loan. If rates in the US are at 6%, and you have 6% yearly devaluation, the lender is looking to receive a yield in the range of 12%, plus they may also require a higher yield based on additional risk factors for the Mexican lending environment. With the robust real estate market and rapidly raising real estate prices that Mexico is experiencing, lenders are much more comfortable making loans in Mexico. Prime real estate properties, coupled with prime borrowers spells a good lending environment in Mexico. Fortunately interest rates for USD loans are considerably less than 12%.

A last consideration a lender has had to look at is the lack of a secondary market for loans made on properties located in Mexico. Unless a lender has large resources of money from which they can fund these loans (such as a bank), it is common for a lender to pool their loans and sell them on the secondary market. Investors purchase these loans, and the lender receives the money to replenish their lending reserves from which to make new loans. At the time this is being written, there is still no viable secondary market for loans on properties located in Mexico, but there are several entities working to put this together. Once a secondary market is in place, you will see an increase in the number of lenders willing to loan in Mexico, and loan terms should be even more competitive.

There are a couple of basic options available when looking at financing your home in Mexico. You will have the option of a peso (MXP) based loan, or a US Dollar (USD) based loan. There are advantages to both, so you will want to look at both to discover which option is best for you. A peso-based loan is generally funded by a bank or investor located in Mexico. The monthly payment is generally a fixed amount in pesos. This payment is set on the day of closing based on the current MXP to USD exchange rate. For example, if you are going to borrow money and your payment would be equivalent to $2,500 USD/month, your payment would be converted to pesos on the day of closing. If the exchange rate is 11 MXP to the USD, your actual payment would be $27,500 MXP per month. If you have a fixed interest rate, this payment amount would never change. It will always be $27,500 MXP until you pay off your loan.

What would change, however, would be the amount of USDollars it would take for you to make this payment every month. The peso has historically devalued against the USDollar at a rate of approximately 6% per year. As the exchange rate changes, your actual cost will change according to the current monthly exchange rate. If in the same example, your payment is $27,500 MXP per month, but the exchange rate is now 12 MXP (instead of 11 when you started your loan), it will now cost you only $2,291.67 vs. $2,500 to make the same fixed monthly payment in pesos, or $208.33 less in US Dollars. This is because it takes fewer USDollars to purchase the same amount of pesos when you are getting 12 pesos to the Dollar versus 11 pesos to the Dollar. This savings of $208.33 is a significant difference in your monthly payment, and as the peso would continue to devalue against the USDollar, your effective monthly payment would continue to decrease as well. Remember also that the MXP loan is disbursed in Pesos, so if you seller is expecting USDollars, it will be up to you, the buyer, to convert the pesos into USDollars, and you will be responsible for the conversion costs.

Generally the way you would make your payment on this type of loan would be to set up a US checking account with the lender. You then deposit your USDollars into this account, and the lender takes out the monthly payment automatically every month, based on the current exchange rate when the payment is taken out. This is convenient, and you don’t have to wire money into a Mexico account every month, which saves you a lot of money. Since this loan is being funded from an investor located in Mexico, the devaluation of the peso DOES affect them.

They have already loaned out their money, and they are getting a fixed monthly payment ($27,500 MXP), but these pesos are worth less and less every month as the peso devalues against the USDollar. Therefore, you will be paying a higher interest rate to compensate for this annual devaluation as was explained previously. A rate of 4-6% higher for a MXP based loan over a USD based loan is what you can expect to pay to compensate for the annual devaluation of pesos.

All of this, of course, depends on the MXP continuing to devalue against the US Dollar. Although there are no guarantees this will continue to happen, there are experts a whole lot smarter than I am who think the basic dynamics between the US and Mexican economies are unlikely to change significantly over the coming years. As of this writing, the USDollar has been at historically weak levels. This means foreign currencies are strong against the USD. During this period of a weak USD, the Canadian Dollar has become very healthy against the USD, and the peso has stayed at basically the same exchange rate. In other words, even during an unusual weakness of the USD, the peso hasn’t gained any ground against the USD (while other currencies have), so in essence, your effective loan payment in USDollars hasn’t decreased, and it hasn’t increased either. It has remained about the same. There is strong pressure from the international markets for the United States to strengthen the USD to more normal levels, which will likely see the MXP once again devalue against the USD. This will have a net result of costing you fewer USDollars to make your fixed peso-based loan payment. It will be back to business as usual.

The other type of loan you can obtain is a USDollar based loan. This is a loan that is funded by a US lending institution, and your payments are made in USDollars. No matter what happens to the exchange rate of the MXP to USD, your payments will not be affected. You borrow US Dollars, and you pay it back in USDollars. Because there is no risk involved with a devalued peso, there is no need for the lender to raise the interest rate to compensate for the devaluation of the MXP. Because of this, you can expect interest rates to be 4-6% lower than a MXP based loan. As was previously mentioned, there are additional risk factors to a lender for making loans in Mexico, so you can generally expect to pay 3-4% higher than similar mortgage interest rates in the US. This margin of difference in interest rates paid in Mexico versus the US will likely become lower in time as lenders become more comfortable lending in Mexico, competition increases, and a secondary market is put in place which will increase money available to loan in Mexico.

Just as you see in the US and Canada, you can expect to see both fixed interest rate and adjustable interest rate mortgages. What is generally the case is that you will see a fixed interest rate in peso-based loans, and adjustable rate loans on USDollar based loans. Although the peso-based loans are usually fixed, they will be about 4-6% higher than a USDollar based adjustable rate loan. Assuming continued devaluation of the MXP, both loans will be approximately equivalent over the life of your loan.

Down payment and closing costs are always a consideration when purchasing a home. Because homes in Mexico are most often 2nd homes, and because of additional perceived risk by lenders lending in Mexico, down payments will be in the 20 - 50% range, with 30% being the norm.

Closing costs for purchasing property in Mexico – whether you use financing or not - are expensive. Be sure to get a good estimate of what your closing costs will be BEFORE you begin to look, as these costs will lower the amount of down payment you have available and will affect the size of home you can purchase. It is difficult to use a “rule-of-thumb” closing cost percentage, because many of the Mexico taxes and fees are fixed amounts regardless of the purchase price, so ask to see what the closing costs will be based on your specific price range and loan amount. Higher down payments will likely required for more expensive properties. Maximum loan amount restrictions may also apply.

One advantage of a peso-based loan has been a lower down payment requirement. Some peso-based loans only require 20% down versus 30%, so your available funds for down payment and closing will allow you to purchase a larger home. For example, $50,000 in available down payment (remember to subtract your closing costs from your total funds to realize your AVAILABLE down payment) with 30% down will allow you to purchase a home price of $166,500 (less loan amount of $116,500 = $50,000 down payment). This same $50,000 available down payment with a 20% down loan allows you to purchase a home price of $250,000 (less loan amount of $200,000 = $50,000 down payment)

Another consideration in looking for a home in Mexico is the minimum loan amount a lender can make. Currently, $100,000 is the minimum loan a lender will make in Mexico. If you consider a down payment of 30%, you will be looking at a sales price of $142,900 or above. A sales price of less than this, with a down payment of 30% would put you below the minimum loan amount of $100,000. If loans below $100,000 are available, expect to pay additional origination points so the lender can receive the income necessary to process the loan. Processing loans in Mexico is more difficult than US loans, so expect to pay origination fees greater than you are used to paying in the US.

Some loan programs are available only to US Citizens, so be sure to identify your citizenship early in your conversation with your lender. Some programs are available for Mexican Nationals living in the US, and some programs are available for Foreign Nationals living and working in Mexico. Citizens of other countries will need to inquire about availability of loan programs based on their citizenship. Remember, you will need a passport in order to close your Mexico mortgage loan. Birth certificates will not be acceptable, so apply for a passport right away if you do not have one.

It is not unusual for loans in Mexico to have some additional provisions. A pre-payment penalty is common on loans in Mexico. This pre-payment penalty may be in the 2-3% range, and may last for the entire life of the loan, or it may be waived after a period of time such as 3-5 years.

Although no one likes to have to pay a pre-payment penalty, this in and of itself, should not be a determining factor in deciding to get a loan right now or not. On a $100,000 loan, your pre-payment penalty would be $2,000-3,000. If you plan on pre-paying your loan in 5 years (for example, after you’ve sold your home in the US and move to Mexico full-time), consider how much the home will have increased in value over that amount of time. This makes the pre-payment much easier to swallow as compared to waiting to purchase your Mexico home years from now and paying a much higher price. Most people who plan to pre-pay their mortgage loan when they obtain it, never wind up paying their loan off early anyway. They usually opt to keep the cash on hand, rather than pre-pay their mortgage, so if your lender allows an option to pay additional points up-front in order to waive the prepayment penalty, this is generally not a good option.

Another consideration for pre-paying your loan might be to refinance at a later time for a lower interest rate. As previously mentioned, it is likely interest rates will fall over time, so it is a strong possibility you may want to consider refinancing your original mortgage loan. If you refinance, you will be paying off your original mortgage early, so you may be responsible for paying the prepayment penalty. Usually the savings you will realize will make up for the prepayment penalty quickly. If you saved 2% interest rate on a $100,000 loan, your monthly savings would be $299.90 (a 7.99% payment is $2,089.54, a 5.99% payment is $1,789.64 based on a 20 year term). If your prepayment penalty is 2% ($2,000), it would only take you 7 months to pay for the pre-payment penalty from the savings of your new loan payment. One thing you may want to ask about when you obtain your loan is will the pre-payment penalty be waived if you refinance through the same lender as your original mortgage was with?. Many times, a lender will waive this if you refinance your loan back through them, but you need to ask about this up front, not when you decide to refinance later.

The term or length of the loan may vary anywhere from 10-30 years. With a 30 year term loan, your monthly payment would be approximately 12% less each and every month than with a 20 year loan. Even though it will take longer to pay off your loan, sometimes keeping your payment as low as possible on a second home (that you’re not living in much of the time) is important both for family budgeting as well as loan qualification. With interest rates being equal, the longer the term, the lower the payment.

Construction loans to build a home on an existing piece of property you own is in it’s infancy. Generally you need to have your property owned, free and clear. A lender may be willing to loan money on the construction of your home under certain guidelines. There will usually be a “supervision of work” expense to you, the borrower, which is for the benefit of the lender to make sure the money they are loaning on the construction of your home is actually being used for materials and labor to build your home. The loan may be given in specific installments. One model that has been used is the lender will lend up to 50% of the land value, and 50% of the construction costs. If your lot is worth $200,000, and you are going to build a home that costs $300,000, the lender will loan $100,000 of the land value + $150,000 of the construction costs, or a total loan amount of $250,000. This money would be given out in three equal draws of $83,333 and each draw would be given when the home is 30% complete, 50% complete, and 75% complete. The value of the land would be considered in these calculations, so since the land is worth $200,000, this is actually 40% of the total $500,000 cost of the completed home. A lender won’t give the first draw until work has started, so you would need to get the foundation concrete work underway before you could expect your first draw. There may be other types of construction loans to consider as well. Construction loans in Mexico are proving to be difficult to find.

Another way to purchase a new property in Mexico is to purchase a home or condo in an existing development. You can either purchase your home in a completed state, or as a “pre-sale.” Generally, if you purchase a home/condo as a pre-sale, the developer will require you to make a down payment, and then make additional payments during the construction phase of your home. These payments can be quite large, and heavily weighted toward the beginning of construction, which allows the developer to use your money to help him pay for the construction costs of your home. It may be possible to obtain a loan during the construction phase of your home and use the proceeds of the loan to make these additional payments. The timing between when the lender will release these funds, and when the developer requires them can be tricky.

Try to negotiate with the seller the smallest payments possible, and the longest timeframe possible in which to make these payments. Even though a developer has a printed, pre-determined schedule, if you ask, they may be willing to work with you. Sometimes a developer will offer their own financing options to help you purchase their property. These options usually require a large (50%) down payment, and the term of the loan is 5 years or less. Sometimes these are done on an “installment contract” basis, which means the title of the property does not pass from the developer to the buyer until the note is paid in full – which could be up to 5 years from when you take possession of your home. This may not necessarily be bad, but you need to check out all the ramifications to your closing costs, transfer taxes, etc. It is also possible you may have to redo your fideicomiso, which would mean additional expenses as well. More than likely, you will not even obtain your escritura (deed) until you have paid off the loan.

There is one last possibility of financing your home that has always been available to a select few. If you have real estate in the United States or Canada, and you can refinance your home, office building etc. to come up with the funds to pay cash for your home in Mexico, you may be able to do this on better terms than you would find in Mexico. Although this option is available to some, many times they choose not to go this route because they don’t want to disturb their US assets, or they want to keep what is going on in Mexico separate from their US holdings/estate. There is also the peace-of-mind of having your US equity available for any future investment/emergency needs. If you use this equity for your Mexico property, you may not have the necessary US/Canadian assets available to borrow against for future needs should they arise. Be careful also about some hybrid loans that use both your property in the US/Canada, AND Mexico as security for your loan. This is probably the worst of all options
Qualifying for a mortgage loan on your Mexico home will depend on your FICO (credit) score, income and total debts. Many people plan to rent their homes out when they are not living in them. Although this is a consideration to help in make your payments, a lender will not use any of this rental income. This would be considered “projected” versus actual stable income, and there is no way to determine rental rates and vacancy factors. Even a previous rental history of the property is no guarantee of future income. Generally lenders will not make a loan on an “investment” property, preferring instead to loan on a “second home” for use by the borrower.

The Mexico lending environment is changing rapidly. Increased competition means more options. Although rates and terms may continue to improve, increasing home prices dictate that purchasing your home in Mexico sooner rather than later is to your benefit. Doing business in Mexico is the same as any other country in the world. Find a real estate agent and a mortgage lending professional who is knowledgeable, and who you can trust to look out for your best interests. Then enjoy your new life in your Mexico home!!