Plunging into Baja

THE trick to buying a home in Mexico, say those who have done it, is to not leave your brain at the border. The days of writing up deals on bar napkins and sealing them with a handshake and a shot of tequila are over — or should be, experts say.

That said, you can buy an oceanfront home in Baja for about one-third of what it would cost 30 minutes north of the border. And that alone was probably enough motivation for the 1.5 million Americans who own homes in Mexico today, according to estimates from the Mexico Assn. of Real Estate Professionals. The number is expected to jump to 12 million within 20 years as more baby boomers retire south of the border.

An AARP study last year ranked Mexico fourth among places in the world Americans are retiring to. As healthcare improves in our neighbor to the south, expect more Americans to get comfortable with the idea, said Mitch Creekmore, coauthor with Tom Kelly of "Cashing In on a Second Home in Mexico."

Fueling the trend is the fact that financing is becoming more available and the process of buying in Mexico more streamlined, transparent and professional.

"Just use common sense," said Mauricio Monroy, a tax expert with the firm of Deloitte in Tijuana, speaking at a September conference at UCLA on buying in Baja. "Apply the same cautions you would have about conducting business in the United States."

The worst thing a purchaser can do, author Kelly said, is to remain ignorant of Mexican law.

Buying a home isn't a simple process, and the rules of the Mexican real estate game are radically different from those in the U.S. To start with, little is regulated, few involved in the process are licensed, and to some extent, a few margaritas may be necessary to achieve the proper level of blind faith.

So before you jump into the Gulf of California, here's the short course on buying in Mexico:

THE HISTORY. The Mexican Constitution says foreigners can't own property within 100 kilometers (62 miles) of the border and 50 kilometers (31 miles) of the coastline. Foreigners have always been able to directly own land in the interior, with a few limitations on specific agricultural tracts. But for second homes or retirement, Americans want the beach. Since the early '70s, non-Mexicans have been able to purchase coastal and border properties through a Mexican bank trust known as a fideicomiso.

HORROR STORIES. Back in the 1980s and 1990s, land and homes in Mexico were so cheap that even if all the Ts weren't crossed, Americans — giddy at the prospect of how far their dollars would go — bought them. Many were in held in ejidos, communal land agreements that date back to the time of Aztec rule in Mexico. Under the ejido system, the land is owned by the government and supported by a national bank.

Since the constitutional reforms of the early '90s, ejido land now can be converted into private property and sold to third parties, including foreigners.

But the effect of events such as the eviction of U.S. citizens from the Punta Banda peninsula south of Ensenada in 2000 lingers. In that case, the mostly retired homeowners had built their houses on ejido land, and when Mexico's Supreme Court ruled that the ejido group was not the land's rightful owner, some of the Americans were forced to abandon homes worth hundreds of thousands of dollars.

THE FIDEICOMISO. The closest legal mechanism to a fideicomiso in the U.S. is a family trust. The bank — the "trustee" — holds the legal title to the property. The trust "beneficiary" (the foreign buyer) holds all rights and privileges of ownership. The beneficiary has the right to occupy or rent the property, and can transfer the title to any legally qualified person. Beneficiaries can modify the property in accordance with local zoning regulations and receive the full appreciation on the property when it is sold.

Trusts have an initial term of 50 years and are renewable at any time for a $1,000 fee for additional 50-year periods.

Banks charge a predetermined fee to establish a fideicomiso, plus a percentage of the property's value, to cover the costs of preliminary studies and the drafting of the trust agreement. The bank also charges an annual fee to maintain the trust, about $500 per year.

THE DEAL. Real estate transactions involve several players, including the buyer's lawyer, a notary public who functions as a neutral agent to both buyer and seller, a real estate agent or broker, and a bank.

The notary public is a licensed attorney hired to oversee the transaction. The notary makes sure that the person selling the property has the authority to sell it, that all back taxes have been paid without any outstanding liens and that all permits are in order. Although the notary will get a certificate of no liens or encumbrances and a certificate of no tax liens against the property, he or she is not responsible for securing a clear title. The buyer and/or his attorney do that.

In the U.S., if a title search turns up a problem, lenders will decline to lend money and alert the buyer to the problem. But most Americans buying in Mexico pay cash, so there is no lender providing this safeguard.

Concerns about whether title is clear have been somewhat alleviated now that title insurance is available. The Stewart Title Guaranty Co. began underwriting title insurance in 1993 for Mexican properties. Title insurance costs about $5 per $1,000 (for example, if the property costs the equivalent of $200,000, the title insurance would cost $1,000.) First American and Fidelity also write title insurance in Mexico. If you can't get title insurance on a property, don't buy.

In the Mexican home-buying process, buyers put down a deposit and then do the title search. If the title winds up not being clear of encumbrances, there is a risk to the buyer of losing his or her deposit because some developers apply it toward construction upon receipt, and the buyer has little recourse to recover it.

The role of real estate agents is also somewhat different. Agents in Mexico are not subject to any national certification, licensing or educational requirements. The best a buyer can do is deal with an established agency whose references they have checked personally.

A lawyer must be hired to oversee the transaction and protect the buyer's interests. There is no formal escrow process, although accounts are now starting to be available via private escrow companies and run from $1,500 to $1,800 per transaction. Buyers should insist that an escrow be opened or that, at very least, the developer be bonded.

There also are no home inspection agencies or home warranty policies. Other types of insurance, including property, liability, damage and earthquake, are all inexpensive in Mexico, and policies can be written to pay claims in U.S. dollars.

FINANCES. Financing is relatively new in Mexico. Most Americans pay cash or take advantage of developer financing programs.

"Cash is king," said Justin Mehren, director of business development for CS Financial, based in Beverly Hills. And much of that cash came out of homes in Southern California as owners refinanced during the last few years and bought vacation or retirement homes in Baja.

Right now, there are several three- and five-year loans available from U.S. lenders for Mexico purchases. And, said Joshua Erskine, senior mortgage banker with Charter Funding, based in San Diego, 30-year fixed-rate loans will be offered as well in the not-too-distant future. Currently, Charter offers three- and five-year loans amortized over 30 years with a 7.99% start rate.

Mortgages also are available from Mexican banks. Given the historical erosion of the peso in relation to the dollar, some developers claim that the Mexican lending rate is the equivalent of a 5% interest-rate loan if it were set in dollars. Getting pre-approved is recommended.

TAXES. Property taxes hover around 0.5% annually but are paid on the assessed value of the land, not on any improvements. There also is a 2% tax on acquisitions. So on a purchase of a $300,000 home, $6,000 in taxes would be due at closing.

If you rent out your unit when you are not occupying it, the U.S. government expects you to report it on your income-tax return. So does the Mexican government, apparently, but few property owners do. The reason seems absurd: It's nearly impossible to register yourself as a taxpayer, says lawyer Jose M. Larroque, principal partner with the Tijuana firm of Baker & McKenzie, who has handled hundreds of closings for U.S. citizens.

"You could say it is popularly ignored," Larroque said.

Upon the sale of your unit down the road, the U.S. and Mexican governments both will be there to claim their share of your capital gains. In Mexico, you pay up to 29% of the gain, which is the sales price minus the amount you paid, adjusted for inflation, and improvements. The notary handling the sale acts as a withholding agent to ensure that Mexico gets paid its due. In the U.S., capital gains tax is 15%, but you can take a credit for the Mexican portion of your tax bill.

MEDICAL CARE. There are half a dozen or so hospital centers near Baja expatriate communities and plans for more to be built, including facilities in Loreto and Rosarito. Many Americans still retreat "home" for treatment of serious illnesses. Medicare and most private insurance plans end at the border, but Mexican health insurance is available for about $300 annually.