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TheMoveChannel.com | Foreign Currency Mortgages

Introduction

Foreign currency mortgages can be used for one of two purposes. While most property buyers are likely to be aware of the first use - buying property abroad - fewer people probably know that it is actually possible to get a mortgage for your home in the UK denominated in a foreign currency.

Instead of lending you a mortgage in pounds Sterling, a bank advances you the money in an alternative mainstream currency, such as US dollars, Japanese Yen, or Euros. The value of this debt is then converted to pounds Sterling on the foreign exchange (usually through the same financial institution that lent you the money) and you then use the British currency to buy your new property.

Your mortgage debt remains in the foreign currency and interest is also charged in that currency, usually in the prevailing rate of interest for that country or zone, as opposed to the one denominated by the Bank of England. Although the debt is also paid off in the foreign currency, this is done by making appropriate monthly payment in Pounds Sterling and selling this money on the foreign exchange.

Advantages

The main advantage of foreign currency mortgages is simple: They give you the opportunity to borrow money at a lower rate of interest than is possible in the UK. This can be achieved by choosing a country that has lower lending rates of interest than we have in the UK.

A £150,000 loan repaid over 25 years at 6.75 percent would give you monthly repayments of approximately £1,050. If you borrowed the same mortgage in Japanese Yen, for instance, at a rate of 2 percent, then your monthly repayments would be around £650. This would be a staggering monthly saving of £400!

If the currency markets work in your favour, then there is scope for further savings to arise from favourable in the exchange rate. If the pound climbs in value against the currency in which you took the loan, then you will need to spend fewer pounds to buy the same amount of foreign currency you initially borrowed. This means that in real terms, your mortgage has actually decreased and your monthly repayments will be lower in pounds Sterling. Alternatively, if there is provision to do so in the terms of the mortgage, then it would be possible to maintain the level of the repayments and clear the debt early with a lower total interest bill.

Given the volatility of the foreign exchange markets, these fluctuations can be quite sizeable. At one point in 2000, the Euro had declined almost ten percent against Sterling in less than a year, meaning tens of thousands of pounds knocked off the total repayment bill for any lucky British residents who had earlier taken out a Euro mortgage.

Given the increasing propensity of companies to spread their operations across Europe, many workers in this country find themselves being paid in Euros and hold Euro-denominated bank accounts. It can therefore be convenient to have a mortgage that is also in Euros, as this would stop them having to pay bank charges for converting their Euros to pounds Sterling in order to pay their mortgage. Someone who is paid in Euros does not enjoy the same potential for currency exchange gains with a purely Euro mortgage as someone whose main currency is Sterling, but nor are they exposed to the risks mentioned below.

A final advantage - and one that will not necessarily appeal to all borrowers - is that continental lenders often lend on much longer fixed terms than UK mortgage companies. The average length of a fixed period can be anything from five to fifteen years in France and mortgages can be found with fixed periods lasting as long as twenty years in Germany. This gives you the security of having a rigidly fixed long-term budget and knowledge of your repayment as far into the future as you could realistically need to.

Risks

Foreign currency mortgages are rightly described as being for risk-friendly speculators. As has already been mentioned, foreign exchange markets can be extremely volatile at times. Just as the value of Sterling can go up against the foreign currency of your choice, so too can it go down. And down. And down.

If the worst happens and Sterling crashes against the currency in which your mortgage has been taken, or the loan currency has a surge of strength, you can find your monthly repayments rising rapidly, without any real limit to the exposure. If Sterling fell by 10 percent on a £150,000 loan borrowed in Euros at an interest rate of 5.5 percent, for instance, you could end up paying as much as £100 extra each month, due to the fact that the Sterling value of your loan has risen by ten percent.

The more that you borrow, the greater your exposure to the risk and the more you could end up having to pay if the currency swings go against your favour. Given the relative strength of Sterling at the moment, it would seem that this risk is a fairly real one.

Most lenders will forward you an absolute maximum of 75 percent of the property value for a foreign currency mortgage. While this protects them against fairly sizeable currency swings and ensures that the repossession value of the property in the loan currency will almost certainly be sufficient to repay the debt, it doesn't really give you any protection.

Many foreign banks shy away from this type of lending, as the thought of going through the English legal system to repossess he house or recover their funds is enough to deter many of them from offering this type of service. They are also aware that many borrowers may not be fully aware of the full effect that swings in the exchange rate can have.

At the end of the day, there is the possibility to enjoy success on the foreign exchange and lower monthly repayments as a result of a reduced interest rate. But the bottom line is, only consider taking out a foreign currency mortgage if you are able and prepared to tolerate sizeable increases in the size of your repayment and definitely get specialist advice before going ahead with any transaction.

Finally, it should be remembered that the prevailing rate of interest in a country does not always reflect the rate at which mortgage lenders will offer their home loans. For instance, although the rate of interest maintained by the European Central Bank has been consistently lower than that maintained by the Bank of England, the gap between the lending rates in the UK and across the Euro zone has not been so wide, thanks largely to the high level of competition in the UK mortgage market.

Multi Currency Mortgages

Foreign currency mortgages do not always have to be in any single denomination. There are lenders who will allow you to spread your mortgage across a range of different currencies.

It is possible to take a portion of the loan in one currency and one or more other portions in currencies of a different denomination. Although this can be seen as a way of spreading the risk, as not all currencies will strengthen or weaken against the pound at the same time, it is a relatively inefficient way of doing this.

The option that is likely to be more effective in reducing risk and maximising the currency exchange effect, is to use a multi-currency switching facility. This means that you are able to switch the currency in which the debt is held and interest charged. Though you need to be aware that broker commissions may eat into the potential gains to be made, this facility does afford you the opportunity to keep moving your debt into the most advantageous currency, depending on the prevailing rates of interest and the direction in which exchange rates are moving.

Say you originally borrowed in Dollars, but they are climbing against Sterling rather quickly. This means that the amount you owe is actually growing in Sterling terms, as the same amount of Sterling buys less Dollars. At the same time, the Euro is tumbling against both currencies - a fact which would normally have no effect on your loan. If you have the facility to switch your debt to the weakening currency - Euros - then you are effectively acting to further reduce the balance of your loan, as Sterling is able to buy more Euros for each pound you have at your disposal.

While this system of debt management can be a really effective way of cutting your mortgage, you are exposing yourself to a risk that can end up costing you a lot on a monthly basis if it goes wrong. You are also committing yourself to a venture that really takes a lot of time, observation and good judgement to be effective - things that are not that easy to ensure as an amateur borrower. But if you are willing to pay the management charges on top of the other costs, there are a number of professional debt management firms that will undertake this sort of operation on your behalf, but then you will be adding management charges to your costs and there's still no guarantee that they will be successful.

Buying Abroad

The second major use - and easily the biggest - that UK nationals have for foreign currency mortgages is for buying property abroad.

Buying property abroad is normally easier if it can be done without a mortgage. Most mortgage lenders will refuse to lend on a property that is going to be let out commercially, because of the risks involved. Letting law on the continent is biased towards the rights of the tenant and it can be a long, drawn out and expensive legal process to evict of them. They may well turn a blind eye if your property is to be occupied by friends and family, indeed some encourage it, but you will struggle to get a loan for a buy to let property abroad.

Assuming that you are not in a position to buy the property outright, you must decide whether to arrange your finances from the UK or use a local lender in the country where you are purchasing a home.

The decision is often made easy by the difficulty that many Brits face in getting a mortgage through a local bank. Outside of the major towns and cities, very few of them are really set up to deal with the needs of foreigners. Whilst they may have the massive advantage of detailed knowledge of the local market and all of the relevant legislation, the language barrier can be an insurmountable stumbling block even for those who are proficient in the local tongue. The complicated paperwork and bureaucratic process take specialist linguistic knowledge which would really require a bi-lingual level of knowledge in order to properly understand and the bank may be unwilling or unable to provide this service for you.

British lenders arranging mortgages abroad are a little more conservative than if you were buying here, but often still more flexible than local lenders. A number of them also have dedicated departments that are experienced in overcoming the difficulties that British nationals face when buying property abroad.

In terms of product technicalities, the maximum LTV is generally from 65 percent to 80 percent, while the term is commonly a little shorter than in this country, sometimes as brief as 15 years. The interest rate that you pay is normally a fixed percentage above what is known the LIBOR rate (the London Inter-Bank Offered Rate). Most lenders that offer foreign currency mortgages will charge you between one and two percent above the LIBOR rate.

The Process

If you do use a UK lender, it is usually best to use one with a local operation in the country where you are buying. Not only does this help with the practicalities of the valuation, transfer of title, legal formalities, and the language problems, banks with specialist local knowledge are usually more able to assist in helping you understand the vagaries of the purchase process in your destination country.

To give an idea of why you will probably need some expert help, here are just some of the differences that you may face:

The cost of buying abroad is often a lot higher than in the UK, particularly in Portugal, Spain, Italy and France, where you can end up paying 10 or 15 percent in estate agent fees, legal charges, mortgage registration fees and VAT. These higher purchase costs impact your total expenditure quite heavily and you need to lower you budget for the property accordingly.

Whilst negotiating is part and parcel of property transactions in this country, the way we do it is not a patch on certain parts of the continent. Vendors in the Mediterranean countries in particular, incorporate a large portion of bluff into the asking price and if you don't go in with a sufficiently low offer, you may end up paying over the asking price.

In France you have to make a potentially non-refundable 10 percent deposit at the point the sale is agreed, so expert legal advice is crucial to ensure that you insert the correct clauses into the agreement document to make sure you don't lose the deposit if the sale falls through.

Under Spanish and Portuguese law, any debts on the property you buy automatically pass to you when you complete the sale. This can include debts relating to any previous mortgage on the property, making it essential that the legal work is done thoroughly.

Tax considerations can play an important part in the way the transaction is approached. Many European countries operate a system based on Napoleonic law, which means that everything is different when compared to the UK - inheritance law, rights over property, court procedures and so on. When inherited property is passed on in many European countries, in the absence of a local will it is split pro rata between family members, rather than all passing to next of kin.

Tax avoidance is endemic in Italy, so getting accurate valuations can be tricky. The official valuation can be 50 percent of the purchase price in order that the taxes associated with the sale are reduced.

Using offshore companies is the only way of buying property with certain lenders in Portugal. The company owns the property and shares in the company are passed from the vendor to the buyer. Changing inheritance legacies is then a matter of reallocating ownership of the shares. However, while this is often the only way to do it in Portugal, it is an extremely costly way to do it in Spain or Italy. Meanwhile, France has the SCI - the Societe Civile Immobiliere, which replaces this form of tax efficient mechanism.

These are just a handful of the many differences - there are many more...