An alternative method for gearing a property purchase of Bulgarian real estate

The Bulgarian mortgage market has been expanding steadily over the last 2-3 years and local lenders have been increasingly hungry for fresh clientele. This has made such lenders market mortgage products more forcefully to domestic buyers than ever before. Against a background of intensifying competition, the tables are beginning to turn, and yet this is not quite a borrower's market.

Retail mortgage interest rate and the accompanying charges are high compared to developed mortgage markets in Europe. Typical rates canvass the 8-12 per cent. ground. Charges, administration fees, early redemption charges and other costs add to an APR in the early to mid teens.

Such high cost of capital is offset though by the expectation of continued capital gains in real estate and the comparatively high cost of alternative residential, holiday and commercial space. Looking for a wider market, local lenders have realised the potential need of foreign-based borrowers (Piraeus Bank, London; Credo Consult, Sofia .)

To gear themselves, small and medium sized foreign property investors are prepared to pay the costs involved, and have used mortgage products available both locally and in their home markets. An alternative which is increasingly offered by lenders entering the fray is the "property leasing contract", effectively a hire-purchase deal involving real estate.

Leasing companies are typically offshoots of financial institutions which specialise in consumer and industrial credit. They have grown their markets in car and equipment loans, but growth rates and competition in these are beginning to slow and this makes it sensible for them to compete in the property sector. But does it make sense for the borrower and what are the peculiarities to watch for?

One possible drawback of the higher purchase agreement stems from the absence of an in rem interest in the lease item in the borrower. Throughout the duration of the arrangement, it is held in the name of the lender, and may in fact be mortgaged on to a further lender which finances the cashflow of what now becomes the sublender. In the case of a default or bankruptcy for the lender, the borrower is in a less advantageous position in theory than would be a borrower from a classical mortgage lender, such as a bank. The creditors of a bankrupt bank will not have a claim and control over the mortgaged property other than what the bank had already had. They would not, barring default by the borrower, be able to call in the mortgage just because of events affecting the lender. Not so with the leasing company lender, which can face claims by creditors which they will feel obliged to satisfy out of all proprietary interests they can get their hands on. Will the affected and innocent borrower be able to defend itself by means of an application to court demanding judicial intervention? Hardly likely.

Of course, bank lenders are also potentially bailed out in ways in which smaller and less formal lenders such as leasing companies and consumer credit unions are not. Government guarantees to depositors will not apply to the creditors of a leasing company.

But where the law does not offer an immediately obvious solace, a combination of the market and law does. Leasing company lenders can purchase in favour of their client and transfer enforceability rights to an insurance policy warranting against their own risk of illiquidity or bankruptcy. Such a contract is only negotiated/resold by the lender and therefore no issues of privity can arise.