When it comes to getting the best conditions for a loan, quite a few people play with the idea of betting on a foreign currency loan. But this type of credit involves many risk factors that could make you regret this decision quickly. 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 settled in a foreign currency – as the name suggests. In most cases, such loans are taken out in Swiss francs, US dollars or Japanese yen. The disbursement of the credit sum takes place thereby naturally in euro. Installment payments and other expenses are made in the foreign currency. Why to do it? Well, at first glance there are some advantages here. The most important are the following:
- Currency speculation: In many cases, you can save a lot of money if the euro performs positively against the foreign currency.
- Lower interest rates: in many cases foreign currency loans have lower interest rates than euro loans. Thus the credit costs sink altogether.
- Conclusion despite negative Schufa: Institutions that issue foreign currency loans, and are located abroad, sometimes allow you to conclude a loan. Even if you have a bad credit score according to Schufa.
Whether it is a personal loan, a corporate loan, or a mortgage loan, a foreign currency loan can 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 read at first glance very attractive. But if you analyze the situation in general, it quickly becomes clear that such a loan is associated with very high risks, so that especially as a private person should be rather cautious. If the situation develops against one's 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 amount of interest to be paid on the loan depends on the prime rates set by the national banks of the respective currencies. And since foreign currency loans usually do not have a fixed interest rate, with such a loan you are particularly exposed to the fluctuations of 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 of the loan. 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 that of conventional loans can quickly turn into the opposite. The bottom line is that the interest rates on a foreign currency loan can contribute significantly to the increased cost of the loan, as they account for the largest share of the costs.
Exchange rate risk
Currencies in the international forex market are subject to fluctuations of almost greater magnitude than interest rates. In recent years, for example, the Swiss franc has become much more expensive against the euro. And such a revaluation for a foreign currency loan usually means that the loan becomes significantly more expensive Because if, for example, the Swiss franc appreciates by 5 percent against the euro, then the loan also becomes more expensive by 5 percent. And this can quickly amount to a large sum, especially for larger loans, which must now be repaid additionally.
Of course, a currency can also devalue – then such a loan would become cheaper. So exchange rate risk can become as much a curse as a blessing for both the borrower and the lender. It is very difficult to predict the situation, especially if the term is more than five years. The exchange rate of a currency depends on a large number of economic and monetary policy developments, and the longer the period, the more difficult it is to forecast.
Repayment risk
With a foreign currency loan one must usually also conclude a so-called repayment vehicle. This is usually a life insurance or existing fund policies, in which the borrower must pay to repay the loan. Here one must consider very well, on which repayment vehicle one sets. 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 generate the desired return. This can ultimately lead to nasty surprises that make the loan much more expensive than anticipated.
Other risks of a foreign currency loan
The above three risk factors are the most important ones 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
In the case of a foreign currency loan, it should be assumed that it will always be made at the best exchange rate. However, 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. In this regard, it is worth investing enough time to carefully review the fine print of all these cases where conversions come into play, and renegotiate here if necessary.
Swap and hedging costs
With foreign currency loans, you always have the option of changing the currency or even the repayment vehicle if they do not perform as desired. However, it is not uncommon for such a loan modification to incur significant additional fees.
Conversion date
In many cases it is only possible to change the currency of the foreign currency loan in a certain period of time. Often this is only every three months. A lot can change economically in such a long period of time, which further increases the risk of a foreign currency loan.
Increase of the collateral
If an exchange rate moves to the borrower's disadvantage, the borrower can sometimes ask for additional collateral. Also to maintain the credit. For example, one can be ordered to increase the mortgage. In such situations it can sometimes be very expensive.
All these situations and risks make a foreign currency loan an undertaking that should be considered very carefully. If you want to play it safe, you are definitely better off with conventional loans. in any case you will sleep more calmly.
No matter if it is also a car loan, a personal loan, or a corporate loan. At LoanStar, by the way, you can use the free loan comparison tool to easily determine which loans have the best terms for you individually. Just try it now!