The Purchase of Credit

We would like to briefly and succinctly present a type of investment that is not very common among small investors or individuals but can be very interesting due to the high returns it can offer. This is the purchase of credit guaranteed by a mortgage. In the financial world, this is known as Non-Performing Loans (NPLs). These are technically loans that have been unpaid for a minimum of 90 days.

What does it mean to buy or acquire a mortgage loan?

In this type of transaction, we are not directly purchasing a property, but acquiring the mortgage loan secured by the property. In other words, we take the position of the creditor, which is generally a financial institution. Let’s imagine a company XXX that has a mortgaged property in a state of default, meaning with pending payments. The bank/creditor has three options to recover this debt:
  • That the debtor pays.
  • Claim the debt and follow the legal process until the auction of the property to recover the credit.
  • Sell the credit to a third party.
  • When opting for the sale of the credit, the creditor must be willing to accept a significant discount.

What does it mean to sell the debt with a discount?

Since this is a doubtful debt, and the creditor will receive immediate payment (with the corresponding savings in legal and subsequent sales costs), the seller must accept a discount on the guaranteed amount. The buyer must evaluate this based on the outstanding debt amount, the days the loan has been unpaid, the stage of the legal process (if applicable), the appraisal value of the property at the time the credit was granted, and its current market value. From these factors, we will determine the potential margin of the transaction and, therefore, the discount or haircut we can negotiate with the seller based on our profit expectations. For example, a creditor holds a debt from company XXX for which 400,000 euros are owed, and they sell it to us for 250,000 euros so that we, the buyers, take their place and continue the legal claim. At the time, the property was appraised at 600,000 euros, and it currently has a market value of 500,000 euros. Since, in the worst-case scenario (the situation varies depending on whether the auctioned property is the debtor’s primary residence or not, and whether the property covers the debt), we would acquire the property at auction for 420,000 euros. This would leave us with a gross margin of 250,000 euros – 42,000 euros (transfer tax) = 208,000 euros, without accounting for possible costs of refurbishing the property and the subsequent sale. Another option that exists in an auction, if acquiring the property is not of interest, is to defend our credit so that any third-party bids above the 250,000-euro credit purchase price up to 400,000 euros—the total debt—will result in a capital gain, excluding the expenses related to the purchase. Obviously, this type of transaction requires thorough analysis by an expert to assess whether it can be a good investment. The key points to analyze are as follows:
  • Analyze the debt. Amount, conditions, and whether it is owed by an individual or a company, and whether they are a consumer or not, as well as the registry rank.
  • Analyze the property. Valuation, condition, and occupancy status.
  • Analyze the legal process. The status or phase of the legal proceedings and the judicial district where the case is being handled.
  • Taxation of the acquisition: The buyer is responsible for the taxes since the seller is recovering their debt, not generating a taxable profit.

Assignment of simple credits, without real collateral.

    1. Assignor as a business entity: Subject to VAT, but exempt.
    2. Assignor as a non-business entity: Subject to TPO (Transfer Tax) at 1%.

Assignment of mortgage credits.

  1. Assignor as a business entity: Subject to VAT but exempt. However, it must be formalized in a public deed, which will be taxed at 1.5% on the mortgage liability (outstanding capital + interest and costs).
  2. Assignor as a non-business entity: Subject to TPO (taxed at 10%).

Subsequent taxation:

  1. Assignment of simple credits: The gain (recovered amount – assignment price + expenses) will be taxed under corporate income tax or personal income tax.
  2. Assignment of mortgage credits: The capital gain will be taxed under corporate income tax or personal income tax.
As you can see, this type of real estate investment requires a strong legal team to assess the viability of the transaction, not only from an economic standpoint but also from a procedural and legal perspective. At Colomer Ventalló, we not only advise clients who wish to buy credit but we also regularly have products available. We are at your disposal for any questions or inquiries you may have on this matter.