# Mortgage loans from foreign banks at lower interest rates

I had a thought - what if I live in a relatively poor country like let's say Russia and I would like to buy a house. In order to do that, I need to take a mortgage loan. In Russia however, interest rates are pretty high, lets say the best offer from a bank is 15 % annually. That's a lot but due to high interest rates, unlike in rich EU countries, the housing prices relative to income are not that high.

What does stop me from taking a loan from a bank in a rich EU-country to build or buy a house in a poor country like Russia, while having EU-level interest rates below 3% instead of the Russian 15%?

## 4 Answers

The low interest rate will be in a different currency. If your domestic currency falls in value, the value of the mortgage in terms of the domestic currency goes up.

Entities borrowing in a foreign currency and then running into difficulties is a standard features of financial crises over history.

What does stop me from taking a loan from a bank in a rich EU-country to build or buy a house in a poor country like Russia, while having EU-level interest rates below 3% instead of the Russian 15%?

Other answers have already mentioned the currency risk you would have. Further limitation is that most European banks won't give you a loan at 3% interest for buying a property in Russia.

In general the low interest rates are for secured loans, for which the location of the asset matters a lot. For unsecured loans, interest rates in EU area are also over 10%. Furthermore, many banks won't give unsecured loans to foreign nationals because of the legal hurdles in trying to recover money in case you stop paying.

I agree with @BrianRomanchuk's +1 answer but I would like to expand on it to give you some more intuition why that holds.

According to a simple monetary model of exchange rates, the exchange rate between two currencies (here Euro and Russian Ruble) is given by:

$$S = (m - m^*) -\psi( y - y^* ) + \lambda (i - i^*)$$

where $$m$$ is the log of money supply, $$y$$ the log of real output $$i$$ the interest rate and $$*$$ indicates foreign party - so from Russian perspective that would be Euro-zone.

The model says that the exchange rate depends on the difference between money supply in RU and Euro-zone, difference in real output and difference in interest rates. So in a long run equilibrium the exchange rate already accounts for the fact that interest rate between Russia and Euro-zone is different. That is in the long run equilibrium you cant just make any profit from interest rate differential alone.

This being said, even given the above you might actually be able to save some money by borrowing in foreign currency. The reason for this is that exchange rate fluctuates not just based on the changes in the interest rates but also the other two fundamentals - money supply and real output. If the money supply in Euro-zone will grow faster than in Russia, or if Euro-zones real economy will experience worse growth than Russia the ruble might become stronger and since your debt is set in nominal terms in euros you would be profiting of that.

However, doing the above is basically an equivalent of speculating on the foreign exchange market. It is equivalent of borrowing in euro to buy ruble and then hoping ruble will strengthen relative to euro enough so you can pay the loan back with interest and keep some profit. You can do that if you want but I personally would not recommend doing that - especially if you are not willing to take the risk that the exchange rate will develop the other way and you will loose money.

Furthermore, the above relationship is based on long run equilibrium. In short run there might be some arbitrage opportunities that might allow you to make risk-less profit from borrowing in another currency - but those usually dont last long and you have to know what you are doing to spot them.

As @BrianRomanchuk's mentions households that tried to do this in history often run into difficulties. You can google some 'financial horror' stories about Hungarian euro-denominated mortgages if you want. Of course, sometimes people actually benefit from having foreign currency denominated mortgage but its a risk and it is probably better to leave exchange speculation to professional forex traders.

• The euro is a currency, but the EU is not a country. Can you edit you answer? :) – Chris Melville May 31 at 6:48
• @ChrisMelville I did edit it although EU conventionally treated in trade models as a country, see some textbooks like Krugman et al international trade theory and policy so I don’t understand what is the problem here by using same simplification – 1muflon1 May 31 at 9:52
• Thanks. It may be treated as a country for some purposes, but it’s simply factually incorrect to call it as such: that’s all. – Chris Melville May 31 at 17:27
• I think the horror stories were worse with Swiss Franc denominated mortgages in non-Swiss countries – Henry Jun 1 at 10:16
• @Henry you are actually completely right in my mind I was looking for examples where Euro played a role but these are much better example – 1muflon1 Jun 2 at 21:36

The question is not restricted to mortgages. You're really asking about generic interest-rate arbitrage---borrow from the country with lower interest rate and lend (in your case, buy a house or become a mortgage lender) in the country with higher interest rate and earn the spread. This would lead to risk-free profit if there is no exchange rate risk---clearly not true in practice. A severe enough depreciation of rouble against the euro can wipe out profit from spread. Interest collected in rouble may not cover loss in value against the euro.

In practice, proprietary FX traders attempting such interest-rate arbitrage do so on a hedged basis. They hedge exchange-rate risk using currency swaps---basically paying a counterparty a risk-premium to bear the interest-rate risk. However, the higher the exchange rate risk, the higher risk-premium demanded by the counterparty. The risk-premium (insurance payment) could be so high that the interest rate spread is no longer profitable after hedging cost.

(If you're the counterparty selling this insurance policy and you deem exchange rate risk to be high, you would charge a high premium, like any insurance provider. Alternatively, the two parties in the swap contract could have different views regarding macroeconomic factors that influence future fluctuations of exchange rate. In this case, you both believe you're getting a bargain and you can't both be right. Somebody will take a loss.)

Short answer---there is no free lunch.

That is not to say borrowing in foreign currency is uncommon. Indeed, non-US corporates and governments commonly issue what is called a eurodollar bond---a debt contract denominated in USD issued by a non-US entity, e.g. a city government in China or a company in Turkey. However, the purpose of issuing eurodollar bond is to access USD liquidity, rather than arbitrage. The yield and coupon payments on such bonds would already reflect difference in interest rates, as well as credit risk of borrower.