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Should you vote for a euro loan?

Euro fever is in vogue again. The currency has fallen dramatically over the last year against most other currencies, including the pound, and, despite international central banks&#39 intervention, the euro still looks weak and beleaguered.

Sounds like bad news, but not if you have a euro-denominated mortgage. Last year, both Barclays and Abbey National promo-ted euro mortgages, offering variable rates at less than 5 per cent, well below the prevailing UK mortgage rates at that time.

Lucky euro mortgage-holders have seen over 25 per cent wiped off the sterling value of their mortgages over the past year – a significant windfall indeed. With euro rates still lower than in the UK and prospects of yet further falls in the euro, should we all rush out and get euro mortgages instead of sterling-denominated ones?

Our view is absolutely not, unless you have very special circumstances. If your income is paid in pounds, which is the case for the vast majority of UK citizens working and living in this country, having a euro mortgage can be very risky. If the euro rises against the pound, then not only will the sterling value of the mortgage balance increase but also the sterling value of the monthly repayments. If you are paid in pounds, such rises could be very costly, especially as a house is at risk if mortgage repayments cannot be paid.

But are euro mortgages for UK residents sensible for those who are paid in euros? While in this case, mortgage repayments as a percentage of income would be immune from euro exchange rate movements, they would still be totally dependent on euro market interest rates. Presently, these are relatively low and so there is a strong likelihood they will increase over the coming year.

Any variable-rate mortgage leaves the mortgage-payer exposed to possible interest rate rises and these can increase the burden of mortgage debt repayment dramatically, as many who lived through the early 90s will all too clearly remember. Generally, more people should seek to take out fixed-rate mortgages rather than variable mortgages, even if the fixed rate is higher than the prevailing variable rate.

One should think of any extra cost of a fixed-rate mortgage as an insurance payment that guarantees interest rates willnot go higher. Most households pay out hundreds of poundsa year on contents and house insurance without wanting tobe burgled or to have their house burn down. Similarly, households should not mind initially paying a few pounds extraa month to guarantee that mortgage rates will not becomeexorbitantly high and unaffordable.

But this begs the question, why not take out a fixed-rateeuro mortgage? This mortgage has the advantage of ensuring the debt repayments will remain constant relative to a stable euro-denominated salary. However, the total amount of debt (fixed in euros) is still free to fluctuate quite markedly relative to the value of the house (priced in pounds sterling), due to euro/pound exchange rate movements.

For example, consider a euro mortgage presently worth (in UK money) £65,000. Say this is secured against a UK property valued at £100,000 (hence the mortgage-holder has £35,000 of his or her own equity invested in the property). If the value of the euro rises 20 per cent relative to the pound, the sterling value of the mortgage will also rise by 20 per cent (to £78,000). While the relative burden of debt repayments will not change (salary is paid in euros), the sterling value of the mortgage has increased by £13,000, reducing the available equity in the house from £35,000 to £22,000 (a fall of nearly 40 per cent). If the mortgage-holder needed to sell the property quickly, the effect of this exchange rate movement would be very costly indeed.

If the euro mortgage was of a higher value relative to the value of the house (for example, equivalent to a sterling value of £90,000 against a value of a house of £100,000), then a risein the euro relative to the pound could well increase the sterling value of the euro mortgage debt to well above the value of the house. The owner would then be in “negative equity”. In this case, unless an alternative source of wealth was available to reduce the mortgage debt, such as savings, the owner would be unable to move house. His castle would turn into a prison until either UK house prices rose sufficiently or the euro/ pound exchange rate fell back again.

All this illustrates the many risks involved in taking out a euro mortgage in the UK. It is absolutely not for the faint-hearted and not that attractive for many of the brave-hearted either.

A euro mortgage would be much more appropriate for a euro-salaried individual if he or she was buying a euro-valued house. But then this house would not be in the UK but on the other side of the Channel in Euroland. For those hell-bent on euro mortgages, being over there rather than over here may well be the best place for them.


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