Mexico Real Estate: Evaluate In-house Development Financing

This Mexidata.info article ties in directly to Baja Fair Trade's recommendation that any financing should be tied to real property rights (i.e. a mortgage) instead of a promissory note.

By Brian Flock

The Mexican coastline from Baja California to Cancun is dotted with beautiful developments and spectacular development proposals that offer in-house financing to real estate buyers. This type of financing can be attractive for buyers when they are dealing with reputable developers who are financially sound. Yet in the sometimes shaky world of Mexico real estate there are risks involved to some in-house financing, but those risks can be managed.

Financially strong sellers usually offer in-house financing for three basic reasons. First, it can be an effective marketing tool to reach potential buyers that might not otherwise qualify for a loan through US sources, or who don’t want to affect their credit in the USA. Also, it allows the seller to offer flexible, customized loan terms that commercial lenders can’t match. Finally, it can differentiate a financially sound seller from a smaller competitor who does not have adequate cash to do their own financing.

American buyers using their cultural assumptions may believe that opting for in-house financing is just a simple cost/convenience decision. The in-house loans are easier to set up than any of the commercial loans. Some in-house rates are now only slightly above the commercial loan rates and up-front closing costs tend to be lower. Yet there is a downside to some in-house financing offered in Mexico that should cause buyers to stop and think carefully.

There is no problem with in-house financing provided that the seller is financially sound, with money to cover expenses and cash flow. The challenge is that the buyer doesn’t really know the seller’s financial condition. In fact, most buyers are not aware of the true condition of the property’s title. There are cases where developments offer in-house financing because they know that the property cannot actually qualify for a loan from a commercial lender. Therefore, buyers must ensure that the financing documents protect their interests.

I recommend that buyers do the following:

1. Determine whether the property still qualifies for a regular commercial loan, even if the buyer actually intends to use in-house financing. The deal should be made contingent on the property qualifying for a commercial loan at closing. Include a contract clause that allows the buyer to receive a complete refund, and be freed from further obligations, if the property doesn’t qualify. If the property can’t quality for a commercial loan because of title problems or permitting issues, this is a major red flag.

2. Contractually treat the in-house financing just like a normal Mexico mortgage (hipoteca) at closing, instead of a simple promissory note. This will require a full closing before a Mexican notary in order to ensure that the buyer’s loan payments reduce the loan principal and increase the buyer’s equity in the property. This is critically important. All commercial loans are handled as mortgages against the property, whereas some in-house programs don’t deliver title (i.e. rights to the property) until the buyer fully pays the note. This is a major difference.

3. Look for pre-qualified developments that have already partnered with commercial lenders. The fact that the seller is “pre-qualified” is not a guarantee of future loans by the commercial lender, but is indicative of some previous research by the lender. Even if there is already a lender relationship, it is still important that the contract terms require the seller to maintain the property’s eligibility for commercial lending.

4. Seek other signs of seller financial strength, such as willingness to accommodate full escrow of deposits until delivery, performance bonds, or voucher control.

5. Be particularly careful of a document called a pagaré, which is a promissory note. If the buyer does not have possession of the unit, such as in the case of a preconstruction contract, they have not received anything in exchange for the promise to pay. The buyer has no control over when the property will be delivered. But, they have just signed a separate contract to make payments, often on a predefined date. If the buyer reads the documents carefully they may even discover that the promissory note contains no references to the sales contract or delivery of the unit. In other words, if the seller never delivers the unit or the title, the buyer could still be obligated to pay.

Using these tips to analyze in-house financing options will help buyers in Mexico find the path to a rewarding coastal investment.

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Brian Flock, a Mexidata.info guest columnist, is a degreed and certified real estate broker in Baja California, Mexico.  Founder of the Baja Fair Trade registry, he may be contacted at Baja Ocean Realty or (619) 793-5224.