Foreign mortgages: top 10 hidden pitfalls

According to Rightmove, a UK company, about 20% of Spanish and French, 25% of Italian and 35% of US clients buy property with a mortgage.

Taking out a loan is beneficial, especially in European countries: the interest rates in Austria, Germany, Switzerland and France rarely exceed 2% per annum, while in the US they run at 4%, and in emerging markets they reach 8% and above.

However, lower rates often imply hidden pitfalls: risks, restrictions and additional requirements imposed on foreign borrowers.

1. Currency risks

Most often, banks grant foreign borrowers with mortgage loans denominated in the currency of the country where the property being acquired is located. For instance, a Brazilian national receives a salary in real, buys property in Germany and takes out a euro-denominated loan. If it is a rental property, the investor uses rental income to pay for the loan. In this case, both the income and the mortgage expenses are euro-denominated. However, if the buyer has acquired a property for own use with a loan and the only source of income is a real salary, there is a risk of mortgage expenses growing when the Brazilian currency falls.

Sometimes, EU banks issue loans denominated in the currency that is foreign to both the borrowers and themselves: the Swiss franc (CHF). In such cases the risks are even higher. As reported by the Guardian, between 2003 and 2008 many UK nationals were taking out franc-denominated mortgage loans. The Swiss currency was considered stable, and the interest rates denominated in it were lower than those for euros and pounds. However, with the beginning of the 2008 crisis, the franc exchange rate soared, and mortgages in this currency became much more expensive. As reported by the Telegraph, in 2007, UK nationals David and Michelle Wilkinson bought a house near the Cypriot resort of Ayia Napa for £130,000. They made a down payment of £30,000 and took out a franc-denominated loan equivalent to £100,000. Due to the growth of the Swiss currency, the Wilkinsons’ monthly mortgage repayments went from £300 in 2009 to £800 in 2013.

2. Floating rate risks

Banks grant loans with floating and fixed rates. The floating rates change along with financial market indices (inflation, bond yields, interbank offered rates: Euribor and Libor) and the fixed rates remain stable during the whole loan term.

Many clients prefer floating rates, as they are lower, and so more attractive than the fixed ones. In Italy, for example, the average fixed rate is 3.5% per annum, while the average floating one is less than 3%.

Although floating rates seem attractive, it should be taken into account that the bank will alter the rate in light of the slightest change on financial markets. As a result, the loan may be impracticable. For instance, many Canadian nationals still remember how in 1980–1981 the rate in their country rose from 15% to 21%.

3. Drawn out process

Another common risk is related to the fact that the period between applying for a mortgage and closing the transaction often takes months. Sometimes, the buyer applies for a loan in July, and the transaction is closed only in December. The procedure takes especially long when the mortgage is re-registered from one borrower to another. Not all the sellers are ready to wait so long.

Buyers spend a particularly large amount of time opening an account needed to make a deposit, obtain a mortgage and subsequently pay the bills. “To transfer money to an account in Europe or the US, the buyer needs to explain the origin of funds. It is a rigorous procedure that can take several weeks or months. It is very likely that, without having amassed the funds in a foreign account in advance, you will miss out on an interesting offer,” George Kachmazov, managing partner at Tranio.com, says.

Daria, the buyer of an apartment on the Côte d'Azur, told Tranio: “You have to make a preliminary deposit in order to make a reservation. This may present itself a challenge for foreigners that do not have bank accounts in France, and opening an account is a complex procedure for non-EU citizens. It comes with long and thorough due diligence of the source of the funds that you deposit on the account, and accounts in other European banks will not help. It took us about three months.”

4. Limited loan maturity

The banks of some countries, for example, Germany and Switzerland often provide residents with 30-year and longer-term loans. “Here is how it looks: during the first decade the rate is fixed, but it can change later depending on the economic conditions,” Kirill Schmidt says. For instance, the buyer of a €100,000 apartment in Germany borrows €50,000 from a bank for 10 years at 1.5% per annum and pays as little as €145 per month for the mortgage. In a decade, the buyer renews the contract for another 30 years to repay the remaining principal (€40,000).

Many non-residents want to take out loans for 30 years or more to reduce their monthly payments. However, the banks of most countries provide foreign buyers with mortgage loans for 10 or 20 years at most.

The shortest loan terms for non-residents are in the United Kingdom and should be repaid within two to five years. A property valuing £1M, an interest rate of 4% per annum, a five-year loan term and own funds amounting to £500,000, means monthly payments to the bank will be about £9,000. In addition, the bank will turn the loan application down if the monthly mortgage repayments exceed 40% of the buyer’s salary.

5. Loan-to-value ratio limits

In Austria, the United Kingdom, Hungary, Germany, Portugal, France, the Czech Republic and some other countries, non-residents are generally eligible for 50–60% LTV (loan-to-value ratio) at most.

Moreover, when buying commercial property, there is a risk that the bank will give even less than 50%. “If the property's rental contract is coming to an end, the bank can decrease the loan to 30% or 20% of the property’s value. The bank may calculate the available mortgage amount in a way that the borrower will have to repay the debt even before the end of the rental contract,” Kirill Schmidt notes.

The banks of some countries also issue loans based on the assessed property value, which can be higher or lower than the market one. "If the assessed value is lower, the buyer doesn’t get enough funds, and if it is higher, the bank will take two figures — the market and the assessed values — and choose the least of them to calculate the mortgage amount. This is done for the borrowers not to get 100% LTV,” Kirill Schmidt says.

6. Property value limits

The banks of many countries establish minimum and maximum loan amounts.

For instance, taking into account the minimum loan amounts and the maximum LTV ratio, in Italy, a property bought using a mortgage cannot be cheaper than €50,000, and, in Switzerland, such a property must cost at least €580,000.

By contrast, in other countries mortgages are difficult to obtain to buy expensive property. For instance, taking into account the maximum LTV ratio, mortgages are not issued for purchasing real estate valued at over over €130,000 in Hungary, over €220,000 in Bulgaria and over €830,000 in Cyprus.

7. Loan denials to individuals

Sometimes banks turn down foreign individuals and legal entities but agree to lend to businesses that have been opened in their countries.

According to Kirill Schmidt, as of early 2017, loans are not available to non-residents in Germany, as the banking legislation demands that the banks only work with the German subjects. Therefore, non-resident borrowers have to open local companies (Gesellschaft mit beschränkter Haftung, GmbH). “It is important for the head of the company to reside in Germany and be a German speaker — this makes it clearer and more convenient for the banks,” George Kachmazov adds.

As denoted by Kirill Schmidt, the banks sometimes ask that individuals personally secure the loans issued to legal entities: “It is considered easier to recall a loan from an individual than from a bankrupt company. However, it depends on the country’s legislation.”

8. Additional guarantee requirements

Banks often require additional guarantees from borrowers who are going to buy commercial real estate, as in these cases the loans are paid off with the rental income.

Andrey, a businessman from Odessa who bought two apartments in the Austrian town of Graz, told Tranio: “The bank asked for the same documents that we used to open an account as proof of funds. We also provided the bank with guarantee letters from the developer stating that the apartment was to be rented out and, even if a tenant was not found instantly, the developer will cover the rent and utility bills, so the bank did not face any risks. In the end, an Austrian bank offered us a mortgage for 50% of the property value at 2.5% per annum for 15 years. Obviously, we took it.”

9. Permanent income requirements in the country

Some European banks require borrowers to have a permanent income in the country where they are going to obtain a loan.

Maria, a Tranio client who bought an apartment in Vienna, told us: “I applied to the two local banks I had already opened accounts with to obtain a loan. Both of them declined my applications for the reasons of being a foreign national and not having a personal income in Austria. As a result, I only managed to get a loan with a third bank when Tranio’s partners in Austria stood as my guarantors. They have a profound knowledge of the procedure and the requirements for execution of documents, so that I didn’t have any problems and my interview with the bank’s experts went smoothly.”

10. Extra costs

At the time of taking out and paying off a mortgage, the borrowers incur a great number of expenses related to it. If you take these expenditures into account, the cost of the loan increases significantly.

Despite the difficulties, taking out a mortgage loan to buy foreign property, especially for investment purposes, is beneficial for the following reasons:

• leverage: getting a loan can increase yields;
• options: more choice or larger properties become available;
• taxes: the interest rate is deducted from the profit tax base;
• quality: as they are subject to comprehensive bank examination, loans are only granted for good properties.

Yulia Kozhevnikova, Tranio