Foreign currency loans for real estate financing – here’s what you should watch out for

Nowadays there are more and more ways to finance a property. A very interesting approach here is financing through a foreign currency loan. As tempting as this method is, there are some risks you should be aware of. At the same time, this form of real estate financing also offers you an opportunity.

In this article, we explain to you what is important in a foreign currency loan for real estate financing and what you should pay particular attention to.

What is a foreign currency loan?

A foreign currency loan is a loan that you take out in a foreign currency. If you live in the euro zone, for example, loans in US dollars, swiss francs or the turkish lira would be a foreign currency loan. Not only do you receive the money in a foreign currency, but you also have to pay the monthly installment and interest in the foreign currency.

What is the difference between a foreign currency loan and a normal loan??

The big difference between the two types of loans is the currency in which you will receive and have to repay the amount of the loan.

Furthermore, foreign currency loans are often bullet loans. This means that during the regular term you will pay only the interest. The actual debt will be paid in one go at the end of the term.

In this case, many banks therefore provide for additional insurance (e.G. Endowment life insurance) so that you can bear the high burden in the end.

What are the advantages and disadvantages of a foreign currency loan??

The purpose of a foreign currency loan is to obtain financing at lower interest rates or to speculate on exchange rate developments in your favor. Within the EU, it is likely to be very difficult to obtain lower interest rates, as the banks in the individual countries are dependent on the monetary policy of the european central bank – in any case, most EU countries have adopted the euro as their official currency.

During the period of low interest rates, interest rates in germany were so low that foreign currency loans were less necessary. Due to the current increase in interest rates, a look abroad could be even more worthwhile from now on.

The advantages or. The opportunities that arise from a foreign currency loan are primarily:

  • Often lower interest rate
  • Possibility to achieve high profits due to currency development

In contrast, there are the following disadvantages:

  • High risk due to appreciation of the foreign currency
  • Often bullet loans with long maturities (thus usually higher interest rates)
  • Fewer offers and therefore less flexibility

Financing real estate with a foreign currency loan: example

But what would a foreign currency loan have looked like in the past?? We will demonstrate this with a positive and a negative example.

Case 1: you benefit from the foreign currency loan

In 2011, you decide to take out a loan for the purchase of a property in the amount of 300.000 euro paid. After a long research you decide to apply for the loan in turkey.

So you want to take out a foreign currency loan in lira, even though the interest rates at that time were around twice as high as in germany. However, you are speculating on a profit due to a loss in value of the foreign currency.

You will receive financing on the following dates due to your impeccable credit rating:

  • Euro/lira exchange rate: 1 euro = 2.30 lira
  • Loan amount: 690.000 lira (300.000 euro)
  • Interest rate: 7.5 percent per annum (monthly rate 4.312.50 lira)
  • Term loan

So every month you pay 4.312.50 lira (at the rate of 2.30 around 1.875 euro per month) of interest (51.750 lira per year). At the end of the 15-year term you would have 776.500 lira in interest paid and then still have to pay a whole 690.000 lira to pay the actual debt (1.4665 million lira). If the euro/lira exchange rate remains stable at 2.30 until then, they would be 637.Pay 000 euro for the loan.

With an annuity loan in germany at 3.5 percent interest and a repayment rate of 2 percent, your monthly charge in germany would be just 1.375 euro per month. After 15 years of fixed interest, you would have paid 247.500 euros paid. Your remaining debt would then be 181.586.98. You can then pay off this residual debt or finance it again. If your conditions remain the same, you would have to pay a total of 477 euros for the property.593,16 € paid.

We now take a closer look at the repayment. For the sake of simplicity, we will not use monthly fluctuating exchange rates, but rather the annual closing rates.

 

Year lira exchange rate euro residual debt lira remaining debt euro total paid
2011 51.750 2,44 21.209 690.000 282.786 21.209
2012 51.750 2,35 22.021 690.000 293.617 43.230
2013 51.750 2,96 17.483 690.000 233.108 60.713
2014 51.750 2,83 18.286 690.000 243.816 78.999
2015 51.750 3,18 16.273 690.000 216.981 95.272
2016 51.750 3,71 13.948 690.000 185.983 109.220
2017 51.750 4,55 11.373 690.000 151.648 120.593
2018 51.750 6,06 8.539 690.000 113.861 129.132
2019 51.750 6,68 7.747 690.000 103.293 136.879
2020 51.750 9,11 5.680 690.000 76.619 142.559
2021 51.750 15,23 3.397 690.000 45.305 145.956
2022 51.750 18,47 2.801 690.000 37.357 148.757

 

So after the first 12 of the 15 years, you have so far 148.757 euros in interest paid. Although no money has yet flowed into the redemption, your remaining debt in euros is only 37.357 euro. The loan in the amount of 300.000 euro you would therefore have 186.114 euros if you pay off the loan now.

So despite the higher interest rates and the poor starting position, it would have been enormously worthwhile so far. By the way, if the development continues like this, they would pay even less in euro terms. With bullet loans, the possibility of early redemption is much more frequent than with annuity loans. At best, you should negotiate this in advance.

Case 2: you pay more

The example can now be turned around. An investor from turkey could have taken out a loan in euros for the lower interest rates in germany. In the end, with insufficient liquidity, this would certainly have led to private insolvency.

On the following dates, the investor in turkey receives the financing in 2011:

  • Euro/lira exchange rate: 1 euro = 2.30 lira
  • Loan amount: 300.000 euro (690.000 euro)
  • Interest: 3.5 percent per year (monthly rate 875 euros)
  • Maturity of loan

For a bullet loan with an interest rate of 3.5 percent, this would amount to 875 euros per month in 2011 (2).012.50 lira) and in 2022 16.161.25 lira. The remaining debt of 300.000 euro would instead of 690.000 lira now costing as much as 5.541 million lira. In the end, this would have cost the investor well over 10 times as much (in lira).

A similar scenario could occur if you take out a foreign currency loan from germany in a stronger currency with lower interest rates.

Which currencies are particularly popular?

Foreign currency loans for real estate financing - here's what you should watch out for

Due to low lending rates in japan and switzerland, foreign currency loans in swiss francs and. Particularly popular in yen. But this does not always have to be the case.

Both countries have also seen higher inflation in the wake of the corona crisis and the escalated russia-ukraine conflict. Interest rates in the two countries are therefore also likely to rise in the future.

But: even if inflation is rising in both countries, it is still far below the level in germany or other comparable countries.

Who should apply for a foreign currency loan?

A foreign currency loan is rather not an option for those who cannot get a loan from a domestic bank due to an insufficient credit rating. For a foreign currency loan, a very good credit rating is usually a prerequisite.

In addition, banks can expect further collateral from them. Therefore, a foreign currency loan is particularly worthwhile for liquid real estate buyers who are looking for a favorable option for real estate financing.

What to look for in a foreign currency loan?

In this section, we will tell you the most important aspects you should consider when taking out a foreign currency loan. We also have some important tips for you in this matter.

Repayment is made at the end of the term

Since most foreign currency loans are bullet loans, you pay the loan amount only at the end of the term. This means that you only pay the accruing interest during the whole credit period.

Accordingly, they bear an even greater personal responsibility to actually be able to pay the loan amount at the end of the term. This undertaking becomes particularly difficult when the foreign currency has appreciated in value against the domestic currency over time.

We therefore recommend that you set up a monthly savings plan – plan for an appropriate buffer. An endowment life insurance policy is also worthwhile in this case. Often obligatory. This is how you protect yourself and the bank for the worst case scenario.

Add the possibility of an early redemption, so that you can possibly reschedule the loan with a domestic loan if you fear a bad development of the exchange rate.

Foreign law applies

Foreign currency loans are usually taken out with a foreign bank. Nowadays you can even do this online. However, in this case you cannot refer to the laws and regulations that you know from germany.

You should therefore familiarize yourself with the banking laws in the country of the lender. It may also be worthwhile to hire an advisor to assist you in this regard. In this case, just make sure that the fee for the advisor does not exceed the interest savings.

Healthy risk management: don't speculate too much

At the end of the day, a foreign currency loan is mainly a big speculation. Due to the long term, you cannot estimate how the value of the currencies will develop in the future.

Therefore a foreign currency loan should always be only a part of the financing. In this case, we recommend a maximum share of around 30 percent. Thus, even strong exchange rate changes to your disadvantage would usually still be financeable in case of emergency.

If you have the choice between an annuity loan and a bullet loan, the annuity loan might be more worthwhile from a security perspective. If the foreign currency only appreciates strongly after 10 years, you will have already repaid at least part of the debt.

Conclusion: what you should know about foreign currency loans for real estate financing

You can save interest by taking out a foreign currency loan, but you are taking a very high risk. Therefore, you should not use this type of financing if you have no possibility of paying off the entire amount in one go.

In our opinion, a foreign currency loan is therefore particularly suitable as a speculative investment if you are very liquid and can react to changing market conditions without difficulty.

Otherwise, you are in a much safer position with domestic financing, even if you end up paying higher interest rates.