Foreign Currency Mortgages – what are they and what are the risks?

Summary
Foreign currency mortgages could save you a lot of money but the risks are high. This article explains.

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99.9% of borrowers raise the mortgage they need to buy their home in pounds sterling and pay the prevailing UK based interest rate. But it does not have to be that way……..

Whilst by its' own historical standards, the UK's domestic interest rates are low, they are still significantly higher than in the Eurozone, America, Switzerland and indeed, Japan. Therefore, you can currently borrow the money you need in Euros, $ dollars, Swiss Francs or Yen, secure the debt against your house in the UK and pay a much lower rate of interest.

The following 3 month money market interest rates illustrate the extent to which UK interest rates are ahead of other parts of the world:

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

But don't expect to borrow money for your mortgage at these 3 month Money Market Rates. You will have to pay a premium for borrowing in an overseas currency. Nevertheless, if interest rates remained as they are now, there will still be significant interest rate savings to be made.

So why are less than 1% of UK domestic mortgages taken out in overseas currencies? The answer: there are extra risks.

Interest rates could buck historical trends and narrow the gap between sterling based interest rates and the rates for the currency in which the mortgage has been borrowed. This would reduce the saving and indeed, at some stage, could make the interest rate more expensive than for a standard £sterling mortgage.

But by far the biggest risk lies in changes in exchange rates. If you have borrowed in say, Yen, you eventually have to repay the loan in Yen. That would be fine if the Yen/Sterling exchange rates were frozen together – but they aren't.

If sterling strengthened against the Yen, then you would have to convert less sterling back into yen to repay the loan than the sterling value of the Yen you initially borrowed. That would be great, an interest rate saving and pay back less than you borrowed. But if sterling fell against the Yen the reverse happens – you end up paying back more capital than you borrowed. So in this context, an overseas mortgage becomes a currency speculation that sterling will not fall against the currency you borrowed. In other words you have converted your mortgage and what is probably your biggest personal liability, into a currency bet. And secured your home against it! You could win but it's not for the faint at heart!

Another point to be aware of is that you'll need a deposit of at least 20% for your house purchase in order to qualify for a foreign currency mortgage.

Incidentally, there is now a second option. You can take out a mortgage in £sterling and have the interest rate you pay linked to a foreign interest rate. Whilst you avoid the currency exposure risk, you are still taking gamble that the overseas interest rate plus the interest rate premium you'll have to pay, will remain lower than the UK's domestic interest rates. These types of mortgage typically have a 5 year tie in clause. Therefore, you'll have a hefty penalty to pay if you want to pay it off early, although the mortgage can usually be moved to another property. For some that represents an acceptable risk, especially if the mortgage is linked to the Swiss Franc interest rate which has been astonishingly low and stable over past years. For example, the interest rates in Switzerland have not moved above 1% in the last 4 years and the Eurozone interest rate has not changed in 5 years.

Nevertheless, part of the wording for a regulated investment warning comes to mind ….. past performance should not be construed as a guarantee of future performance ……

Readers please note : You should undertake your own background checks before taking any action on any aspect mentioned in this article. Where the author has mentioned specific product details or given examples of how companies have reacted to specific situations, these should be correct as far as the author is aware when this article was written. In some cases additional background information not mentioned in the article has been used in obtaining the examples. Some examples or quotes may have been taken from information available in the public domain where all the background details may not be available. Insurers do change policy conditions and underwriting approach. They will view each situation on its own merits.

You should be aware that details of the topics written about within the articles can change. Therefore, always check out the current position before taking any action. You should also check that any action you are considering, or any proposed purchase, is suitable for your personal circumstances.