Cross Currency Mortgages

Although cross currency mortgages have fallen out of favour since the global financial crisis due to historically low interest rates in the West, there are still a few about, so this week is a short piece explains what they are and the main potential risks involved for those using them.

A cross currency mortgage is where some one buys a property typically in a country with high interest rates with a loan that is denominated in a different currency but has a lower interest rate. A further twist that can occur is that the loan may not even be in the currency in which the borrower is paid. As you can imagine, these are complex loans and usually only suited to professional investors who understand the risks or very high net worth individuals who can afford the risks.

In years gone by I have seen loans denominated in Yen and Swiss Francs as popular currencies for lending against properties in UAE and Europe for borrowers based in Dubai. The rationale for taking the loan was that interest rates in UAE or Eurozone are higher than in Japan or Switzerland and therefore by borrowing in Yen or Swiss Francs interest is saved.

What most borrowers fail to recognise is that they are only trading interest rate risk for exchange rate risk. Exchange rates are far more volatile than interest rates, just ask anyone who sends money overseas on a regular basis. A small change in exchange rates can have a big impact on the amount repaid. Additionally, for those who are not paid in the currency of their loan, there will be currency conversion charges, which if done via a bank may add a few more percent onto the cost of each payment. So they are more risky thank ordinary loans.

Like regular property loans, banks rarely revalue the security property but they will keep a very close eye on the exchange rates and if it moves sufficiently against then, banks will reserve the right to request additional capital in the form of a ‘margin call’, see last week’s blog on leverage for an explanation of this. This can come a nasty and expensive shock to borrowers. Unlike leverage for investing in equities or bonds which can be easily and quickly sold on the market, property is relatively illiquid and so selling in the short term for a reasonable price is not usually practical.

So, if you are offered this type of borrowing think very carefully before committing to it as what looks like a good deal now may not be so great in a few years time when exchange rates have changed dramatically.

Please let me know if you have any questions or comments.