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

Nowadays there are more and more possibilities 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 that you should definitely 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 U.S. dollars, Swiss francs or the Turkish lira would be a foreign currency loan. You not only receive the money in a foreign currency, but 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 receive and have to repay the loan amount.

Furthermore, foreign currency loans are often bullet loans. This means that you pay only the interest during the regular term of the loan. The actual debt is not paid until the end of the term in one fell swoop.

Therefore, in this case, many banks provide for additional insurance (for example, endowment insurance), so that you can handle the high burden in the end.

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

The purpose behind a foreign currency loan is to obtain financing at lower interest rates or to speculate on the exchange rate development in your favor. Within the EU it might be very difficult to get lower interest rates, because the banks in the different countries are dependent on the monetary policy of the European Central Bank – anyway most of the EU countries have adopted the Euro as their official currency.

During the low-interest phase, interest rates in Germany were also so low that foreign currency loans were rather less necessary. Due to the current rise in interest rates, looking abroad could be all the more worthwhile from now on.

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

  • often lower interest rate
  • Possibility to achieve high profits through currency development

In contrast, there are the following disadvantages:

  • High risk due to increase in value of the foreign currency
  • often bullet loan with long terms (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 would like to demonstrate this with a positive and a negative example.

Case 1: You profit 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 euros. 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, although the interest rates at that time were about twice as high as in Germany. However, you are speculating on a profit due to a loss in value of the foreign currency.

On the following dates, you obtain financing based on your impeccable credit rating:

  • Euro/Lira exchange rate: 1 Euro = 2.30 Lira
  • Loan amount: 690.000 Lira (300.000 Euro)
  • Interest: 7.5 percent per year (monthly rate 4.312.50 lira)
  • bullet loan

So you pay every month 4.312.50 Lira (At the rate of 2.30 around 1.875 per month) in interest (51.750 lira per year). At the end of the 15-year term, you would have 776.500 liras in interest and then still have to pay in one fell swoop 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, you would therefore pay back 637.000 euros for the loan.

For an annuity loan in Germany with 3.5 percent in interest and a repayment rate of 2 percent, their monthly burden in Germany would be just 1.375 euros per month. After 15 years of fixed interest rate, you would have paid 247.500 euros paid. Your remaining debt would then be 181.586,98 € amount. You can then pay off this residual debt or finance it again. If your conditions remain the same, you would have for the property a total of 477.593,16 € paid.

We now take a closer look at the repayment. For the simplification we do not take monthly fluctuating exchange rates, but namely the annual closing rates.

 

Year Lira Exchange rate Euro Residual debt in lira Residual 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 paid 148.757 Euro in interest paid. Although no money has yet gone into repayment, your remaining debt in euros is only 37.357 euros. The loan in the amount of 300.000 euros would therefore have cost 186.114 euros if you repay the loan now.

So despite the higher interest rates and the poor starting position, it would have paid off enormously so far. If the trend continues in this way, you would pay even less in euro terms. With bullet loans, early repayment is possible much more often than with annuity loans. This is what you should negotiate in advance at best.

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 personal insolvency.

On the following dates the investor on Turkey in 2011 receives the financing:

  • Euro/Lira exchange rate: 1 Euro = 2.30 Lira
  • Loan amount: 300.000 euros (690.000 euros)
  • Interest: 3.5 percent per year (monthly installment 875 euros)
  • bullet loan

For a bullet loan with an interest rate of 3.5 percent, this would be 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 liras now cost as much as 5.541 million liras. In the end, this would have cost the investor far more than 10 times (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 the low interest rates on loans in Japan and Switzerland, foreign currency loans in Swiss francs and. in yen particularly popular. However, 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. As a result, interest rates in the two states are also likely to rise in the future.

However, even though inflation is also 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. Because a foreign currency loan usually requires a very good credit rating.

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

What you should consider with a foreign currency loan?

In this section we list the most important aspects you should consider when applying for a foreign currency loan. In addition, we give you important tips in this matter.

Repayment takes place 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 interest due during the entire term of the loan.

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

Therefore, we recommend that you set up a monthly savings plan – plan for an appropriate buffer. An endowment life insurance policy is also worthwhile for this case resp. often obligatory. How to protect yourself and the bank for the worst case scenario.

Also include the possibility of an early redemption, so that you can possibly reschedule the loan with a domestic loan if you fear a poor development of the currency exchange rate.

Foreign law applies

Foreign currency loans are usually taken out with a foreign bank. Nowadays this is even possible online. However, in this case you cannot rely on the laws and rules that you know from Germany.

Therefore, you should 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 consultant does not exceed the interest savings.

Healthy risk management: do not speculate too much

Ultimately, 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. This way, even strong exchange rate changes to your disadvantage could usually still be financed in case of emergency.

If you have a 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 would have already repaid at least part of the debt.

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

Through a foreign currency loan you can save interest, but you take a very high risk. Therefore, you should not use this type of financing if you do not have the option of paying off the entire amount in one go.

In our opinion, a foreign currency loan is therefore mainly 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 should end up paying higher interest rates.