In the UK over 99.9% of mortgages are borrowed in Sterling and interest is charged the prevailing UK interest rate. But there are alternatives ……..…..

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

Judged against history, you may think that interest rates in the UK are currently low. But look at the following 3 month money market interest rates. You’ll see that the UK interest rate is significantly higher than the rates in other parts of the developed world:

Japanese Yen 0.12%
Swiss Franc 1.03%
Eurozone 2.46%
US $ 4.48%
£ Sterling 4.64%

(3 month Money Market Rates as at 9/12/05, source: Financial Times)

Monet market interest rates are the rates that banks lend currencies to other banks. So you won’t be able to take your mortgage out at these keen rates. You’ll have to pay a premium and the set up costs for your mortgage will be relatively high. Nevertheless, if interest rates remained at current levels, you could save a lot of money on your interest payments.

So why are 99.9% of UK mortgage holders still turning their backs on lower international interest rates? It’s a fact that most UK borrowers are unaware of the availability of foreign currency mortgages - but that’s not the main reason. The primary reason are the extra risks involved.

All interest rates can change and the gap between sterling interest rates and the foreign currency rate you’ve borrowed in, could narrow. If this happened, the interest rate savings would reduce and, if the trend continued, would make the foreign interest rate more costly than a standard UK mortgage.

But the most significant risk by far lies’ in changes in currency exchange rates. If you borrow in say, Swiss Francs, you eventually have to pay the loan back in Swiss Francs. That would be fine if the Swiss Francs /Sterling exchange rate was fixed – but it isn’t.

If Sterling strengthened against the Swiss Francs, then when it came to repaying the mortgage, you’d need to convert less Sterling into Swiss Francs than the Sterling value of the money you received when you first took out the mortgage. That would be great, repay less than you borrowed and pay a lower interest rate!

But things are never that simple. What happens if Sterling’s value were to fall against the Swiss Franc? You’d still have to repay the same number of Swiss Francs but you’d have to convert more Sterling into Francs 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 currency bet. If Sterling rises against the currency you’ve chosen, you’re quids in. If Sterling falls, you lose money. In other words you’ve transformed your mortgage and probably your biggest liability, into a currency speculation. And your home’s secured against the debt! It’s not for the faint at heart!

You should also be aware that most lenders ask for at least a 20% deposit for foreign currency mortgages. It’s a reflection of the increased risk.

By the way, you now have another option to consider. You can take a mortgage in Sterling thereby avoiding the exchange rate risk, and have your interest rate linked to a foreign currency interest rate. This limits your risk to a bet that the foreign currency interest rate plus the interest rate premium, will remain lower than the equivalent UK interest rate.

Typically, these foreign interest rate mortgages have a 5 year tie in clause. So, if you want to repay your mortgage within 5 years, you’ll have a hefty penalty to pay - although the mortgage can usually be transferred to another property. For some borrowers this risk is acceptable, especially if the mortgage is linked to the Yen or Swiss Franc where interest rates have been surprisingly low and stable over past years. For example, the Swiss interest rate has not moved above 1% in the last 4 years.

All the same, part of a standard investment warning is particularly appropriate here ….. past performance should not be construed as a guarantee of future performance ……

If you are tempted by the potential savings, then the best of luck!