A MORTAGAGE MELTDOWN?

Bulgarians who hold hefty mortgages may receive an unpleasant Christmas present from their banks, as yet another increase in interest rates on home loans is just around the corner. According to credit experts, rates will soon rise by 0.5 to 1 percentage point. Some banks have already pushed up their interest rates by almost 2 percentage points this year, and the base interest rate has reached 5.33 percent, its highest level in 10 years. Will credit holders manage to pay their debts or is a wave of US-style defaults imminent? What awaits those who cannot afford to pay the higher monthly instalments?

Optimists believe that a dramatic scenario in which mortgagees lose their homes because of overdue payments to local banks is impossible for two reasons. First, inter-bank competition is seen as a safety net – a loan can always be refinanced by borrowing, either from the same bank or from another. Second, the amount by which the monthly payments would increase will not be as huge as to bust a family's budget. Furthermore, Bulgarian mortgage brokers – unlike their counterparts around the globe – are reputedly extra careful and endorse only applicants who can prove they can service a loan.

Simple statistics show that these arguments lack credibility. In the United States, banks believe that if clients take on a loan whose repayment needs more than 35 percent of their pre-tax income, chances are that they will have serious trouble maintaining mortgage payments for the entire period. Standards are much looser in Bulgaria – applicants can obtain loans with monthly payments equalling up to 50 percent of their income. When a mortgage takes such a large bite out of paycheques, an annual interest-rate rise of only 1.5 to 2 percentage points may turn out to be enough to bust more than a few budgets. Mortgage experts have warned that higher interest rates will have serious consequences for nearly 70 percent of all credit holders.

It was in 2005 when finance professionals first started talking about the mortgaged properties market. Back then banks auctioned off a few dozen apartments because of overdue payments. These were primarily large apartments – three bedrooms or more – in new buildings, all in Sofia. In the following year, properties in other large cities, such as Varna and Burgas, were also on the block. Banks did not see this as a warning sign of an impending bad debt trend, since overdue mortgages accounted for 0.6 percent of all issued loans – a level judged to be perfectly normal. In 2007, however, overdue debt rose to 1 percent, and given the present situation this tendency is expected to continue. This means that banks will auction properties ever more frequently.

But one man's financial ruin may mean another man's real estate dream-come-true. Purchasing mortgaged properties is a way for both parties to profit from an unpleasant situation – the defaulting owner gets his mortgage covered and the buyer gets a cheaper home. Pressed by the need to sell quickly, owners go for underselling the property. For a few entrepreneurial Bulgarians, making money from buying and re-selling mortgaged real estate has become a profitable venture. Most Bulgarians, however, are wary of fraud and red tape, and avoid purchasing mortgaged properties.

The procedure is slow and complicated, although professionals make it sound simple. The seller must inform the buyer that a real estate goes together with a mortgage. Usually, at that point the buyer withdraws. If they accept the terms, there are two options: The buyer may purchase the property together with the loan and begin servicing it, in which case he and the bank sign a new contract. Alternatively, the buyer can repay the entire loan and get rid of the mortgage. In reality, the whole process is nerve-racking and involves countless hours of waiting for various documents. The purchase may drag on for three or four months.

Current legislation is to blame for the complicated procedure. Unlike many European countries, Bulgarian law prohibits banks' confiscating and selling a property once the owner can no longer pay the mortgage. To avoid bureaucratic headaches, lenders prefer to negotiate and persuade the client to sell the property on his own. Usually, at first the owner lists a high asking price, the property remains unsold for a few months and the bank has no choice but go to court. Then either the owner lowers the price or a judge auctions off the property. If the property remains unsold, a second round takes place, but this time the asking price is nearly half the market value.

However, few mortgaged properties ever reach public auctions. If a property is of decent quality and is saleable, the "mortgage mafia" steps in. These are inspectors who work for credit institutions, or other industry insiders. They watch for bad-credit holders and, for a hefty "commission," connect defaulting owners with willing buyers. This practice is not illegal.

Buyers who are willing to go through the trouble of purchasing a mortgaged property usually contact an experienced lawyer or a broker with good connections to the mortgage mafia. For now, this submarket is risky, but a change in the legislation is expected soon which may make it more transparent. However, this is cold comfort to the 70 percent of mortgage holders who may be struggling to hold onto their homes in the near future.