What is a foreign currency loan?

 

A foreign currency loan is actually a speculative deal. The borrower hopes for interest and exchange rate advantages. But that is a risky bet.

A foreign currency loan means that you borrow money in a foreign currency, for example Swiss francs, and you have to repay the loan in this currency as well.

In practice, this is what happens: The bank obtains the loan sum in francs from a Swiss bank, converts it into euros and pays it out to the borrower. To repay the loan plus interest, the borrower gives the bank euros, which it converts into francs and transfers to the Swiss bank.

If you are a lucky borrower, a foreign currency loan may still cost you less than
a normal loan in euros, despite the rather high fees and charges involved. That is because interest rates vary between different currencies.

Borrowers take out foreign currency loans in currencies where credit interest rates are lower than in euros, and they bet on the interest remaining low over time. However, that bet does not always pay off.

And then there’s exchange rate speculation. When the foreign currency drops in value vis-à-vis the euro, the borrower has to repay less. A smaller euro amount has to be converted to cover the debt.

 

Let’s say you take out a foreign currency loan for EUR 100,000 at an exchange rate of 100 vis-à-vis the foreign currency. If the exchange rate drops to 95, your principal debt goes down to EUR 95,000. But if the exchange rate rises to 110, you will suddenly owe the bank EUR 110,000 instead of EUR 100,000.

 

So foreign currency loans carry very high risks: The exchange rate may rise, and that means the amount of debt rises too. The interest rate advantage may also disappear into thin air.

It would be nice to have a soothsayer who could tell you exactly how interest and exchange rates are going to develop. But they don’t exist. Because of the high risk involved, foreign currency loans are only rarely extended to private individuals in Austria today. Moreover, the Financial Markets Authority (FMA) has set strict standards which banks have to comply with:

FMA minimum standards for foreign currency loans