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Mortgage and Finance : Mortgage Tools Last Updated: May 14th, 2012 - 22:24:01


Foreign Currency Mortgages
Michael Challiner
 
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In the UK over 99% of borrowers raise the mortgage they need to buy their home in sterling and pay the prevailing UK interest rate. But there are alternatives.

Despite increases in 2005, the UK's domestic interest rates are low by its' own historical standards. However, they remain significantly higher than in Eurozone, America, Switzerland and indeed, Japan. Therefore, currently you can take out a mortgage in Euros, $ dollars, Swiss Francs or Yen, convert the money you've borrowed into sterling, secure the debt against your house in the UK and end up paying a much lower rate of interest.

You may think that UK interest rates are low, but if you look at the 3 month money market interest rates you'll see that they remain significantly higher than in other parts of the world:

£ sterling 4.64%

$ US 4.48%
Eurozone 2.46%
Swiss Franc 1.03%
Yen Japanese 0.12%


(Source: Financial Times, 3 month Money market Rates, 9/12/05)

But you won't be able to take your mortgage out at these 3 month Money market rates. You'll have to pay a premium for borrowing in a foreign currency and the set up costs will be higher. Nevertheless, if interest rates were to remain as they are now, you could save a lot of money on your interest payments.

So why do 99% of UK domestic mortgage holders still choose a domestic UK mortgage? Most borrowers are unaware of foreign currency mortgages but that's not the main issue. The primary answer is that there are extra risks.

International interest rates are constantly changing and gap between sterling interest rates and the foreign currency rate you've borrowed in, could narrow. This would reduce the interest rate saving and, if that trend continued, could make your interest rate more expensive than a standard £sterling mortgage.

But the biggest risk by far lies' in fluctuations in currency exchange rates. If you borrow in say, Euros, you eventually have to repay the loan in Euros. That would be great if the Euro/Sterling exchange rate was fixed ĘC but they aren't.

If the £ sterling strengthened against the Euro, when it came to repaying the mortgage you would need to convert less £ sterling into Euros than the £ sterling value of the money you received when you first took out the mortgage. That would be great, a lower interest rate and repay less than you borrowed.

But what happens if the value of sterling falls against the Euro as has happened in recent times?

You still have to repay the same number of Euros but you'll have to convert more £ sterling to achieve that. In other words you end up paying back more capital than you borrowed.

So in many ways, a foreign currency mortgage becomes a bet that the £ sterling exchange rate will not fall against the currency you've borrowed in. In other words you've transformed your mortgage and what is probably your biggest liability, into a major currency speculation. And your home's secured against it! You may be lucky and save a lot of money - but it's not for the faint at heart!

Another point you should be aware of is the minimum deposit you'd need for a foreign currency mortgage. Most lenders ask for at least 20%. That's a reflection of the increased risk.

Incidentally, you now have second option to consider. You can take a mortgage in £ sterling and have your interest rate linked to a foreign currency interest rate. Whilst you avoid the biggest risk ĘC the exchange rate risk, you are still taking gamble that the foreign currency interest rate plus the interest rate premium you pay, will remain lower than the equivalent UK interest rate. These foreign interest rate mortgages typically have a 5 year tie in clause. So, if you want to repay the mortgage early, you'll have a hefty redemption penalty to meet - although the mortgage can usually be moved to another property. For some borrowers this represents an acceptable risk, especially if the mortgage is linked to the Swiss Franc or Yen where interest rates have been astonishingly low and stable over past years. For example, the Swiss interest rate has not moved above 1% in the last 4 years and in the Eurozone, the interest rate has not changed for 5 years.

Nevertheless, part of the standard wording for a regulated investment warning is appropriate here past performance should not be construed as a guarantee of future performance

Still too risky for most borrowers!

 

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