Part two of the series explores the key risks of an international mortgage.
Welcome to part two of a three article series explaining what international mortgages are and how they work. If you have not already, please read part one, which introduces international real estate loans and shows how the borrower can save a ton on interest payments. This second article will explore the hidden risk to international mortages.
The key issue with a cross currency loan is Foreign Exchange [FX] risk. Specifically what happens when a currency shift means the "value" of your loan blows out vs the value of your house and paid deposit.
The lender will require you to maintain something called loan-to-value ratio [LVR] during the life of your loan . This ratio measures of the value of the amout you borrowed, vs the actual value of he asset. When these two numbers are in different currencies, a FX rate move can cause an impalance. Your lender will require you maintain a certain ratio and if that ratio slips due to a FX move the bank will ask you to restore the ratio.
Confused? Lets try an example...
We'll use the scenario from part 1 of this series. The deposit is a more realistic 30%, i.e. you have deposited $90,000 and borrowed the remaining $210,000. The loan gets converted to Japanese Yen at the current rate of 80 JPY/NZD, resulting in a 16,800,000 JPY loan. You congratulate yourself for getting such a great mortgage rate and put the letter from the bank reminding you that you need to maintain that 30% “deposit” vs the loan amount into a drawer somewhere.
However just two weeks later, before you have even had time to buy some nice curtains, a certain US investment bank goes under, and the financial markets are thrown into turmoil. Investors dump stocks and “risky” currencies and flee for safer markets, driving the yen to record highs overnight. The result is the NZD crashes vs the yen to a rate of 60 yen per dollar. What does this mean for your loan? Lets put it in the table with some extra rows.
Your loan converted back to NZD is now a lot higher, and the $90,000 deposit on the house price is no longer enough to maintain a 30% LVR as specified by your lender. From the lenders perspective, to cover a $280,000 loan you must pay $120,000 deposit and they will ask you to deposit $30,000 in quick time to restore the LVR to 30%
Now, if you have extra savings in yen which can cover this amount then you’re OK. You make the payment and move on with life. But what if you borrowed $1 million for a house, or $2 million for 3 houses? A $900,000 house would see a bill for $90,000 to the borrower, ouch!
By now I hope you can see that a cross currency loan, while giving you a great rate on one hand, adds significant risk to the borrower. In fact lenders will often require you have cash holdings to buffer a 10-15% currency shift before even allowing you to switch currencies.
Surely this is not all doom and gloom?
Correct! What goes one way can swing the other, and if you time your entry into the market right, a shift in the exchange can deliver great results and I'll cover that in part 3.