Risks with foreign currency loans

Popular: foreign currency credit in francs

When it comes to getting the best terms on a loan, quite a few people are toying with the idea of going for a foreign currency loan. But this type of loan carries 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 implies. In most cases, such loans are concluded in Swiss francs, in US dollars or in Japanese yen. The disbursement of the loan amount is of course in euros. 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 value of the euro is positive against the foreign currency.
  • Lower interest rates: In many cases, foreign currency loans have lower interest rates than euro loans. This reduces the overall cost of the loan.
  • Conclusion despite negative Schufa: Institutions that grant foreign currency loans, and are located abroad, sometimes enable the conclusion of a loan. Even then, 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 may seem very attractive at first glance. But if you analyze the situation in general, you will quickly realize that such a loan is associated with very high risks, so that you should be rather cautious, especially as a private individual. 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.

Germans are particularly likely to take out a foreign currency loan in Switzerland

Interest rate risk

The amount of interest one has 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 called the risk of interest rate changes. A foreign currency loan is usually 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 remain the case for 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 make up the largest portion of the cost.

Exchange rate risk

Almost to an even greater extent than interest rates, currencies in the international forex market are subject to fluctuation. In recent years, for example, the Swiss franc has become much more expensive against the euro. And such a revaluation means for a foreign currency loan usually that the loan becomes significantly more expensive Because if, for example, the Swiss franc against the euro by 5 percent revalued, then the loan is also 5% percent more expensive. And this can quickly amount to a large sum, especially in the case of larger loans, which must now be repaid in addition.

Of course, a currency can also devalue – then such a loan would become cheaper. The exchange rate risk can therefore become a curse as well 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 developments, and the longer the period, the more difficult it is to forecast.

Repayment vehicle risk

With a foreign currency loan, you usually also have to take out a so-called repayment vehicle. This is usually a life insurance or existing fund policies into which the borrower must pay to repay the loan. In this case, you have to think very carefully about which repayment vehicle to use. 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 unpleasant surprises that make the loan significantly more expensive than expected.

Further 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 taking out a foreign currency loan, one should assume that it will always be done 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. In this respect, it is worth investing sufficient time in carefully reviewing the fine print of all these cases in which conversions come into play, and renegotiating here if necessary.

Swap and hedging costs

With foreign currency loans, you always have the option of changing the currency or the repayment vehicle if these do not develop as desired. However, such a change in the loan not infrequently causes sensitive 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 the case only every three months. In such a long period of time, a lot can change economically, which further increases the risk of a foreign currency loan.

Increase of collateral

If an exchange rate moves to the borrower's disadvantage, the borrower may sometimes be required to provide additional collateral. Also to maintain the credit. For instance, one may be ordered to increase the 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 one will sleep more calmly.

No matter if it is a car loan, a personal loan, or a corporate loan as well. At LoanStar, by the way, you can use the free loan comparison to easily determine which loans have the best terms for you individually. Just try it now!

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