Foreign Currency Mortgage

A guide to Sterling, Euro, Dollar and Yen mortgages.

As we’ve seen in the past few decades, growing globalisation is bringing countries closer together than ever before. Being able to fly from Tokyo to London in less than a day, or from Paris to New York overnight, means that now more than ever before people are looking to purchase property abroad. There are fewer barriers to travel, and international finance has had to keep up with the growing pace of globalisation in order to satisfy the needs of modern clients. The need for individuals to purchase real estate and finance it in a non-domestic currency has driven banks to introduce a range of foreign currency mortgage options. This form of mortgage allows buyers to take advantage of flexible financing options, and to potentially benefit substantially when investing in overseas property.

Foreign currency mortgages are often not clearly understood by buyers, which leads many people to dismiss them as overly complex or risky. However, with foresight and careful risk management, along with a good understanding of what a foreign currency mortgage is and what it’s for, this form of finance could be the perfect solution for many investors.

What is a Foreign Currency Mortgage

So, what constitutes a foreign currency mortgage? By definition, this is a mortgage on a property which will be paid off using a currency other than the one in which the mortgage was originally granted; essentially, the same as a normal domestic mortgage, with the added step of a currency exchange before it’s repaid. It’s fairly straightforward, but this additional step adds some complications; a standard mortgage is fairly easy to understand, as the loan is repaid in set “chunks” each month, with the total amount varying slightly according to domestic interest rates. However, when this monthly payment is then subject to fluctuations in the foreign exchange market, things can become more complicated; the total amount payable each month can potentially vary significantly according to the state of the exchange rate.

Who Needs Foreign Currency Mortgages?

Foreign currency mortgages are useful because they allow buyers to pay for their mortgage directly with their own assets. This form of payment is flexible, and can apply in more cases than you might expect; for instance, if an investor holds shares in a US company listed in dollars and intends to repay their mortgage with their sale, they will need to pay for their mortgage in a foreign currency.

This flexibility can be very useful, and allows buyers to access options which they wouldn’t otherwise be able to. For example, a UK expat might decide to purchase their retirement home in the south of France with a mortgage from a French company; however, they might intend to pay for their mortgage with the income from their UK pension, which is held in sterling. Taking out a foreign currency mortgage allows them to do so easily, and provides them with the ability to seek out the best domestic mortgage deals.

Advantages of Foreign Currency Mortgages

As we’ve already discussed, a foreign currency mortgage can allow buyers the option to pay for property in a currency other than that of the original loan. How can this prove valuable, though? Firstly, it allows buyers to take out a mortgage from a domestic company, who may have significantly different rates on offer from a UK lender. This is due to the nature of national lending; the interest rates of each country will vary according to the demands and requirements of their economy, so while a certain level of interest is the norm in the UK, France might offer significantly lower rates. Therefore, it can be extremely worthwhile to take out a mortgage with a French mortgage provider; they could potentially provide a mortgage which is a lot cheaper than the options available from a UK lender.

A second point which makes foreign currency mortgages an attractive choice for overseas investment is the ability to take advantage of foreign currency exchange rates. If the rate of exchange between the buyer’s own currency and their mortgage provider’s currency is favourable to the buyer, it makes sense for them to repay in the more valuable currency. For instance, a loan of a thousand euros might be equal to, say, £800. If this exchange rate should strengthen in favour of the pound, then the buyer could potentially meet their obligation to repay a thousand euros by only paying £700, for instance. Of course, if the buyer were simply to convert their earnings into the local currency anyway, they would still stand to benefit. However, this is not always practical, as with pensions and dividend payments, and the additional flexibility of repaying using an alternative currency is a valuable one for many investors.

Risks of a Foreign Currency Mortgage

The variable nature of foreign currency exchange means that the value of currencies is always fluctuating, sometimes by a large amount every day. This means that, just as the value of the borrower’s domestic currency can increase against the lender’s currency, the opposite can also occur. In this case, the borrower will have to pay more of their own currency in order to meet their repayments; the thousand-euro loan from the previous example could end up costing £1,000, should the pound’s value fall against the euro. This means that borrowers are at a greater risk of seeing their repayments rise, which can make it difficult to budget for the future.

Because of the potential for buyers to find their repayments rising significantly, many domestic banks will not be able to meet requests for foreign currency mortgages. Being able to underwrite the loan requires that they have confidence in the borrower’s ability to repay, but when the additional variable of the foreign exchange market is introduced many banks simply feel unable to approve the loan.

There are two options which buyers can turn to, though, when mainstream banks are unable to meet their requirements: firstly, they can ask a multinational bank for finance. These lenders typically have systems in place to assist in the conversion of payments, and their international nature means that they have to deal with the risks of currency exchange as part of everyday business.

Secondly, buyers can enlist the services of a specialist foreign currency mortgage broker, who will be able to accommodate their specific needs. These lenders work with many buyers who wish to pay their mortgages in a foreign currency, and as such have the experience and expertise necessary to take on the risk of a foreign currency mortgage.

Protection for Borrowers

The exposure to fluctuations in foreign exchange value is one of the most visible drawbacks to a foreign currency mortgage. However, there are certain mechanisms in place to help protect borrowers from this potentially volatile market, and the Mortgage Credit Directive, introduced in 2015, provides investors with some degree of protection. The measures put in place in this document stipulate that lenders must give borrowers the option to swap their repayments into an alternative currency or share the risk of the exchange rate rising precipitously. If the exchange rate between the two currencies should increase by more than 20%, borrowers should be given the option to change the currency in which they’re paying; if the dollar is stronger, for example, the borrower could start to repay using dollars instead.

Alternatively, the lender could implement a “cap” for when exchange rates fluctuate. If exchange rates should increase by, say, 25%, the mortgage provider could offer borrowers the ability to cap their payments at a 20% shift. What this means is that buyers are protected from large changes in the exchange rate, and though 20% might seem like a large leap, today’s uncertain economic circumstances mean that we’ve seen several movements of this magnitude in recent years. The way this cap would work is that the lender takes on a portion of the risk if exchange rates should move. For instance, if a borrower has taken out a French mortgage which is costing them £1,000 per month to repay, and the exchange rates jumps 25% so that they’d have to pay £1,250 per month, their payments would be limited to just £1,200 instead. The difficulty is that although this cap protects the borrower, it means that the lender cannot rely on their loan being repaid; the cap limits the buyer’s payments, but at the expense of the lender. The money which the borrower doesn’t have to repay if the foreign exchange market suddenly jumps will come out of the lender’s profits, which has made many providers of foreign currency mortgages understandably worried.

Foreign Currency Mortgage Managers

One way in which borrowers of foreign exchange mortgages can reduce the possibility of being hit with expensive foreign exchange rates is to hire a manager for their overseas investments. A managed currency mortgage is one which has a dedicated expert to seek out the best foreign exchange configurations for the borrower’s loan, who switches the borrower’s repayment currency into the most appropriate format as often as is necessary. For example, if a buyer purchases a house in euros, but finances the mortgage in sterling, they’re susceptible to fluctuations between the value of sterling and the euro. If the value of sterling should fall, they’ll have to pay more each month to satisfy their repayment schedule; however, the value of the dollar may remain unchanged, and by switching to using dollars to repay their mortgage, the borrower is able to avoid the higher costs associated with the exchange rate of sterling to euro.

A professional foreign currency mortgage manager will use multiple difference currencies to achieve the best possible rate for their clients, sometimes swapping between dozens of different currencies in order to find the cheapest option possible. In some cases, it’s even possible for a wily currency manager to repay the capital on a mortgage whilst their client only pays for the interest on it; they’re able to manipulate exchange rates in such a way that they can increase the value of their client’s payments significantly.

Fixes and Forwards

A currency manager is a great choice for a buyer who has substantial overseas investments, but they don’t come cheap. The costs of hiring a manager might well be worthwhile for large investments, or for a consortium of buyers, but for residential mortgages this might be more than is necessary, and the price of hiring a dedicated manager might be too high. There are other methods of managing the costs of a foreign currency mortgage, though, and buyers needn’t be left at the mercy of the foreign exchange market.

A “forward contract” is an agreement to make a purchase at a certain date in the future, and is commonly used to allow buyers to “fix” their foreign exchange purchase in advance. When purchasing a foreign property, for example, a buyer might be able to confidently arrange a purchase for a given amount of money; $200,000, for instance. At the time, this will cost them £100,000, because the exchange rate is 2:1 in favour of the pound. They arrange a mortgage to cover this cost with a domestic mortgage provider. However, when the time comes to complete the purchase, the exchange rate has changed, and what would have cost £100,000 now costs £120,000. The buyer’s mortgage provider refuses to follow through on their purchase, because the cost is now so much higher, and as a result the deal falls through. A forward contract would allow the buyer to fix the exchange rate at 2:1, taking into account interest rates for both parties – they can then remain confident that they’ll be able to finance the deal at the price they agreed.

This has implications for repaying a foreign currency mortgage, too, because borrowers can arrange a forward contract for their repayments. By “locking in” the current exchange rate, it’s possible for the borrower to arrange to buy foreign currency at a stable price, allowing them to reliably repay their mortgage in full. Forward contracts aren’t the most straightforward deals to agree, and can make repayment of a mortgage a more complicated business; therefore, it’s worth contacting a legal professional in order to help you draw up the agreement in advance, and discussing how best it should serve your needs.

Who Provides Foreign Currency Mortgages?

Arranging a foreign currency mortgage falls beyond the remit of many high street and mainstream banks. The domestic nature of these banks mean that they’re simply not equipped to deal with the difficulties inherent in foreign currency mortgages; this requires a great deal of experience in handling foreign exchange markets, and the ability to quickly and reliably change currencies. As a result, it can sometimes feel that foreign exchange currencies are hard to find, since they’re not widely advertised, but if you know where to look it’s possible to find a wide variety of products to suit any buyer or investor.

As mentioned previously, there are two main channels through which a buyer can obtain a foreign currency mortgage; large international banks or small specialist lenders. Each has their own benefits, meaning that different investors will find it more attractive to utilise different lenders.

Foreign Currency Mortgages from International Banks

Many large multinational corporations offer foreign currency mortgages, and the safety and stability of knowing you’re borrowing from such a large firm can provide buyers with good peace of mind. However, these large enterprises will be processing many mortgages daily, and as a result need to streamline the application process; if your situation is somewhat out of the ordinary, or you have specific requirements which must be met, you might not be able to borrow from a large lender.

Specialist Foreign Currency Mortgage Lenders

The alternative to a large lender is a smaller, more specialised mortgage provider. These businesses cater to the needs of their clients in a more flexible way, and can do more to meet their specific needs. They also benefit from acting as a specialist mortgage broker; their investors understand that foreign currency mortgages are part of the lender’s specialist area, and requests for these loans is not out of the ordinary, unlike with other lenders. This means they can arrange finance quickly and easily, with the minimum of delay.

Is a Foreign Currency Mortgage the Right Choice?

Purchasing property abroad is often a sensible investment choice, and can be a safe, productive addition to a portfolio. Whether this is financed through domestic currency or local currency has an impact on its profitability, and can affect how the investment performs. Generally speaking, financing a mortgage with a foreign currency mortgage presents the possibility to save money, although it isn’t as reliable as a mortgage in local currency would be.

However, if the risks associated with paying a mortgage in a foreign currency are properly understood and handled by an experienced manager, these benefits can outweigh the risks. If your property is an investment, and you wish to generate income from it, a foreign currency mortgage might well be the right choice for you.

Further Reading

Official resources about UK financial regulation and monetary policy:

Other Unofficial Guides

Covering areas of UK regulation on and aspects of Foreign Currency Mortgages.

Research provided by Falbros