"Dación en pago" explained (handing back the keys)

In the aftermath of the Covid-19 pandemic, central banks worldwide flooded the money markets with liquidity (money) in an attempt to stop a major recession which could trigger - if left unchecked - a global depression similar to the last one from 1929.

However, for every action there is an equal and opposite reaction. Flooding the money markets brought about soaring inflation worldwide. Historically, the best way to bring down an unbridled inflation is to (sharply) raise the price of money (interest rates). This – hopefully – cools off the markets (as consumers spend less money) until inflation is brought to heel once again. Anyway, so goes the theory.

All the above sounds hunky-dory, but what does it mean for the common man?

Pursuing these monetary policies means millions of people all over the world, that were already struggling, may now drown financially as they are unable to meet the rising costs of their financial commitments because all of a sudden they have become far more expensive i.e. repaying a bank loan.

A sharp rise of inflation (dubbed as the ‘tax on the poor’) translates into everything becoming more costly. For practical purposes, this means most people now have less money available as disposable income. When money becomes tight, people start feeling the pinch.

A sharp rise of interest rates in turn, translates into higher monthly mortgage repayments. Borrowers need to service higher mortgage repayments every month as result of an interest rate hike. In plain English, this means scores of borrowers now struggle to meet their new mortgage obligations and the idea of defaulting on their Spanish mortgage loan becomes increasingly more likely.

However, defaulting on a Spanish mortgage loan has associated severe legal and financial consequences, even in your home country, that we explain below. It’s not as easy as simply throwing the keys over the counter at your bank.

In this article, we explain a special procedure that can be followed (called dacion en pago in Spanish) which allows you to hand back the keys to a lender without facing ANY legal or financial repercussions. Interested? Read on.

Definition

In plain English, ‘dación en pago’ (datio pro soluto) means handing back the keys to a lender, and in exchange a lender discharges in full the mortgage liability not holding a borrower liable in the future. The lender waives his legal rights to pursue the borrower’s debt in his home country against any assets he holds.

Why hand back the keys? Unlimited personal liability

The main reason on why struggling borrowers follow a dación is because on being repossessed in Spain, if the property slips into negative equity (meaning you owe more money than what the property is worth), a lender can actually pursue the borrower for the difference, even abroad, in your home country.

A dación is a procedure best suited for borrowers who own property, whether in Spain or abroad. What a mortgage borrower seeks on following a dación is to set a legal firewall that will avoid a lender jeopardising the remainder of his assets. It is basically ringfencing the family’s financial assets by (legally) drawing a red line on the sand.

Following article 1911 of the Spanish Civil Code, borrowers are held personally and unlimitedly liable with all their assets, both now and in the future. In other words, the debt goes personally against a borrower. The property itself, the collateral, is accessory, and was only guaranteeing a bank loan, which is the principal. It is often the case that on repossessing a property in Spain, there is a significant shortfall owed by a borrower, as the auction value of the property is not high enough to cover all the associated debt and interests accrued.

Scores of defaulting borrowers realise with horror post-auction, that in despite of a lender repossessing their Spanish property, they are still being chased in their home country for the outstanding debt. As they owe, in addition to the mortgage loan itself, all the repossession associated expenses, lawyer’s fees, court agent’s fees and on top the mortgage default compound interest. The compound default interest on average is over 20% p.a. which only adds more pain on the long run as the overall debt builds exponentially over time.

That is why many defaulting borrowers, in lieu of being repossessed, would rather hand back their keys formally following a dacion en pago procedure. Another powerful reason is that if you default on a Spanish mortgage loan your lender will have you backlisted with all major credit-rating agencies. Meaning next time you need to apply for a loan, or even something as simple as a credit card, you will be turned down by all major credit institutions in your home country. You will become a financial pariah.

In short, following a dacion avoids a nightmare scenario of being chased for the outstanding debt post-repossession.

Dacion requirements

1. No-negative equity rule: the property should not be in negative equity (in fact, I advise it should have at least over 20% equity).
2. No repossession procedure underway: it is critical a lender has not started repossession proceedings against the property.

Dación en pago procedure

A formal procedure needs to be followed at a notary public. A deed is drafted by your appointed lawyer. The borrower formally relinquishes his ownership over the property and in exchange the lender drops any legal actions against him considering the mortgage loan settled. 

The deed is signed by both the borrower (or his legal representative) and his lender. The deed will need to be witnessed by a Spanish notary public.

Expenses involved

A dacion en pago works similar to a conveyance procedure, only that instead of getting paid in exchange of signing your property away you are fully discharged of the mortgage liability being allowed to walk away scot-free from the problem. Expenses involved are negotiable.

Signing the notary deed and frequent mistakes

We strongly recommend you instruct a lawyer to follow this formal legal procedure. This avoids the struggling borrower making a number of mistakes or even being taken advantage of by his lender.

It is not unusual that borrowers - acting without a lawyer - are purposely tricked by lenders into signing before a notary what they think is a dación, but in fact is only an assignment of rights and assets (datio pro solvendo) which does NOT extinguish the debt. This only cancels part of the debt, it doesn’t terminate it.

Meaning the mortgage liability is NOT discharged, which remains very much outstanding. This means the lender can – and will – pursue the outstanding debt abroad which mounts up exponentially over time.

It is standard practice these debts are sold in block to local debt-collection agencies in your home country for a fraction of their book value. E.g. a Spanish lender sells a tranche of defaulted loans to a local UK debt-collecting company who will in turn chase you in England on the arrears against your main home and assets.

Another frequent mistake borrowers make is that a notary is NOT there to give you legal advice, as they act impartially to either side. Their main role is to witness the deed and ensure taxes are paid to the government. A notary is NOT your personal lawyer. Don’t rely on a notary to act as your solicitor, because that is not their role.

Pro-tips

1. Handing back the keys FULLY discharges your mortgage liability, bringing legal closure to the matter.
2. A dación en pago AVOIDS jeopardizing your assets in your home country; you will not be chased abroad on any shortfall and expenses.
3. Following a dacion AVOIDS being blacklisted by major credit-rating agencies, such as EXPERIAN, ASNEF, RAI, etc which may impact on a borrower’s ability.

Dación en Pago - conclusion

A dación en pago is a win-win for both parties.

A borrower is free at last on having managed to successfully ringfence his assets, whether in Spain or in their home country. He can now walk away without fear of facing in the future any legal or financial backlash putting the matter behind him.

A lender on the other hand will now own the property outright and will have successfully waived a lengthy, protracted, and expensive court procedure (bank repossession) without having to set aside the mandatory provisions before the Bank of Spain to make up for this dubious loan which affects its liquidity ratio. A repossession procedure lasts a minimum of 3 years and may easily entail for the bank expenses running up to 20% of the properties’ book value. These provisions set aside by lenders are looked upon closely by credit-rating agencies post-credit-crunch as they hinder their borrowing ability and ultimately dent their stock market value.

At LNA, we are very experienced assisting struggling borrowers to hand back their keys legally, avoiding any legal repercussions. Give us a call. Because peace of mind is priceless.  

At Larrain Nesbitt Abogados (LNA) we have over 21 years’ experience assisting foreign clients buying, selling, or renting properties in Spain. We offer a competitively priced accounting service to file your landlord taxes every tax quarter nationwide. We are also specialized in litigation, and immigration & residency visas. You can contact us by e-mail at info@larrainnesbitt.com, by telephone on our UK line (+44) 07543 838 218, our Spanish line (+34) 952 19 22 88, or by completing our contact form to book an appointment.

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