When it comes to getting the best conditions for a loan, quite a few people play with the idea of relying on a foreign currency loan. But this type of loan involves many risk factors that could quickly make you regret this decision. For the following reasons, you should think very carefully about taking out a foreign currency loan.
What is a foreign currency loan?
A foreign currency loan is a loan that is transacted in a foreign currency – just as the name says. In most cases, such loans are concluded in swiss francs, in US dollars or in japanese yen. The loan amount is paid out in euros, of course. Installment payments and other expenditures are made in foreign currencies. Why to do it? Well, at first glance there are some advantages here. The most important ones are as follows:
- Currency speculation: in many cases, a positive development of the euro against the foreign currency can save a lot of money.
- Lower interest rates: in many cases, foreign currency loans have lower interest rates than euro loans. This reduces the overall cost of borrowing.
- Conclusion despite negative schufa: institutions that grant foreign currency loans and are located abroad sometimes make it possible to conclude a loan. Even then, according to schufa you have a bad credit score.
Whether it is a personal loan, a business loan or a mortgage loan, a foreign currency loan may be tempting, but it carries enormous risks, which we will discuss in more detail below.
Risks of a foreign currency loan
The advantages of a foreign currency loan look very attractive at first sight. But if you analyze the situation in general, it quickly becomes clear that such a loan is associated with very high risks, so that you should exercise caution, especially as a private person. If the situation develops against your own advantage, a foreign currency loan can quickly become very expensive. These factors ultimately determine whether a foreign currency loan was a good decision or not.
Interest rate risk
The interest rate you have to pay for the loan depends on the base interest rates set by the national banks of the respective currencies. And since foreign currency loans usually do not have a fixed interest rate, such a loan is particularly exposed to fluctuations in interest rates. This is referred to as interest rate risk. Usually, a foreign currency loan is taken out when the interest rates in the country of the foreign currency are currently lower than those in the euro zone – and when it is assumed that this will also remain the case over the entire term. However, it is very difficult to predict the development of interest rates over a longer period of time.
And since the national banks act at their own discretion, it can quickly happen that an interest rate that originally represented an advantage over conventional loans quickly turns out to be the opposite. The bottom line is that the interest on a foreign currency loan can contribute significantly to the increased cost of the loan, as it accounts for the largest share of the costs.
Exchange rate risk
Almost to an even greater extent than the interest rates, the currencies in the international forex market are subject to fluctuations. In recent years, for example, the swiss franc has become much more expensive against the euro. And such an appreciation usually means for a foreign currency loan that the loan becomes significantly more expensive because if, for example, the swiss franc appreciates against the euro by 5 percent, then the loan also becomes more expensive by 5 percent. And this can quickly add up to a large sum, especially for larger loans, which now has to be repaid additionally.
Of course, a currency can also depreciate – in which case such a loan would become cheaper. The exchange rate risk can therefore be a curse or a blessing for both the borrower and the lender. It is very difficult to predict the situation, especially if the duration is more than five years. Because the exchange rate of a currency depends on many economic and monetary developments, and is more difficult to predict the longer the period is.
Repayment vehicle risk
With a foreign currency loan one must usually also conclude a so-called repayment vehicle. This usually involves life insurance or existing fund policies that the borrower must pay into to repay the loan. In this case, you have to think very carefully about which repayment vehicle you choose. If you rely on too risky a form of capital accumulation, you may not be able to repay the loan if the repayment vehicle does not create the desired return. This can ultimately lead to unpleasant surprises that make the loan significantly more expensive than expected.
Other risks of a foreign currency loan
The above three risk factors are the most important to consider before taking out a foreign currency loan. But it is also essential to consider other things in order to fully assess the risks:
Conversion
When you take out a foreign currency loan, you should assume that it will always be at the best exchange rates. But there are many situations in which this exchange rate is not set for the benefit of the borrower, but rather for the borrower's benefit. It is worth investing time in carefully reviewing the fine print of all these cases where conversions are used, and renegotiating if necessary.
Swap and hedging costs
In the case of foreign currency loans, it is always possible to change the currency or the repayment vehicle if these do not develop as desired. However, it is not uncommon for such a change in the loan to incur significant additional fees.
Conversion date
In many cases it is possible to change the currency of the foreign currency loan only in a certain period of time. Often this is only the case every three months. In such a long period of time, a lot can change economically, which additionally increases the risk of a foreign currency loan.
Increase in collateral
If an exchange rate moves to the borrower's disadvantage, the borrower may sometimes require additional collateral. Also to maintain the credit. For example, you may be forced to increase your mortgage. In such situations it can sometimes become very expensive.
All these situations and risks make a foreign currency loan an undertaking that should be considered very carefully. If you want to be on the safe side, you are definitely better off with conventional loans. In any case, you will sleep more peacefully.
No matter whether it is a car loan, a personal loan or a corporate loan. At loanstar, by the way, you can easily find out which loans have the best conditions for you individually with the help of the free loan comparison tool. Just try it now!