European mishap? What happens to my property abroad’s mortgage?

December 3, 2012

What happens to overseas holiday home-owners or foreign national property buyers with mortgages, if a country exits the Euro?

I have not come across much written on this topic, so thought I would address it as a “layman” in pragmatic terms, in answer to client concerns about buying abroad, rather than from a financial expert perspective.

The European economic and financial crisis may seem to have gone away, as we have now grown somewhat immune to the shenanigans of individual countries, who, dependent on which press report you read, are either still teetering on the edge of an abyss, or sorting themselves out. But we still need to be wary.

Potential Country downfall – Holiday home-owner-abroad implications?

Holiday Home EuropeSo what is the worst case scenario? Although Greece’s latest loan arrangements seem to tie it over until 2014 there are still questions. Should Greece, or any other country, exit the Euro-zone, what are the chances part of the banking system could crash across Europe in a “Mexican Wave” of failure, as a result of their direct exposure to the failing country’s debt.

For example, there is an exposure to 422 billion Euros of Greek debt (Sovereign, household and Corporate debt according to the International Monetary Fund – IMF). Banks inside and outside the Eurozone would feel the impact if the value of Greek government bond markets were to crash and the banking system were to freeze. The Majority of Greek debt (approx Euro 250 billion) is now the direct liability of other governments.

Many governments may immediately step in to nationalise the bankrupting banks either in part or full as they did in the UK with Northern Rock, Lloyds and HBOS. Country and bank failure would have a serious indirect impact on international financial systems by increasing the price of “risk” (or borrowers, at an individual or country level) as we have seen, in the not so distant past, with interest rates soaring for struggling countries.

The trigger for an Euro exit would be the point when the government is no longer able to pay social security and wages. At this point, the government would need to pass a new currency law, re-denominate all domestic contracts into the new local currency, impose exchange controls and take steps to introduce a new paper currency. Printing and distributing alone could take months, given the logistics of printing and distribution of notes.

In all likelihood, the new local currency would depreciate immediately.  The IMF, for example, predicts Greece would need a devaluation of at least 20% against the Eurozone average just to balance its current account. Such devaluation would increase Greek competitiveness, but would have huge legal ramifications with regard to the existing debt owed to Europe and the IMF.

The danger lies with the capital flows, which are the biggest unknown. The world’s central banks will do their utmost, as they did during 2008, to prevent financial meltdown or contain the damage through a range of mechanisms such as: bank capitalisation, foreign currency swaps, and potentially capital controls.

So for property buyers abroad or European homeowners –which banks are safest?

Europe's BanksSmall banks and building societies are potentially at greater risk than larger banks and building societies. Governments see larger banks posing a greater risk to the financial system and economy and will be more reluctant to let them fail.

Euro-zone banks and more likely PIIGS banks, that is Portugal, Ireland, Italy, Greece, Spain are more likely to be most vulnerable

Part of the risk is in the potential change to the terms and conditions of a mortgage i.e. if a mortgage is sold on by bankrupting PIIGS banks. This has been a characteristic of the US market for a while and so is not an unknown phenomenon. Mortgage “books” can get sold on, as a bank’s strategy or underwriting criteria change.

Many banks on the continent focus more on “cash flow“ lending rather than “collateral“ lending. That is they focus on a buyer’s ability to repay the loan rather than just looking at the housing asset to recover their money.  In order to raise the desired financing, a bank has to be comfortable that a client’s disposable income can cover the difference between the mortgage loan repayment and the prospective rental income and/or the monthly mortgage repayment at full.

So a person with a good credit history is sure to fare better than one without. Wherever a bank has a choice if it needs to prune its client base, it is likely to stick with the better quality “risks”

What are the implications for mortgage rates for foreign national buyers?

Mortgage rates are historically low, partly because of the Bank of England’s and the European Central Bank’s policy of keeping interest rates low.

And investors seek the safest places to put money, seeking Gilts or Treasuries (government funds/bonds), and that factor has been a very important development that has been keeping mortgage rates low.

If a country leaves the Eurozone, it is likely that savings in the state-controlled banks would be converted into local currency which are likely to be worthless. It is also likely that a mortgage could be converted into local currency so mortgage holders could benefit if there is a devaluation-effect (dependent on whether you are a foreign national)

In such a situation would my mortgage debt be almost wiped out?

In normal circumstances if an institution has lent money, then goes bankrupt, unless it is taken over or a “receiver” pursues the money lent out, the mortgagor would still be in receipt of the loaned money. Although, there would still be a charge on the property, by the defunct lender.

Another repercussion if, for example, Greece or Spain pulled out of the euro, it is possible mortgage-holders might pay larger interest payments due to the higher currency exchange between the local currency and the stronger Euro. In a similar way to mortgages taken out in Swiss Francs in countries like Poland and Hungary in the good times, where local currencies were in a strong position compared with the Swiss franc, but where Swiss franc-denominated loan, interest rates were low. But when local currencies  devalued against the stronger Swiss Franc, this meant higher mortgage payments.

Overseas Home Buyer – Conclusion

It is not only a question of which countries and banks to consider when buying a home abroad but also personal circumstances. As ever, it is important to ensure your credit-worthiness is solid and you have a good credit history. Just as you will seek the strongest and best banks, so too will banks be seeking the strongest and best credit-risk, i.e.  you as a borrower.

Some overseas property-buying options worthy of consideration:

(These evidently depend on your personal circumstances and attitudes to risk)

  • Take a mortgage from a bank outside the Eurozone – sterling, Swiss Francs, US Dollars, or move to wholly owned UK bank
  • Choose  one of the bigger banks (following the “too big to fail principle” that Governments are less likely to let the bigger banks go to the wall). E.g Santander for Spanish mortgages , (world’s 15th largest bank, it has over 65 % of its earnings outside Spain)
  • Take a foreign currency mortgage but with the local bank e.g. CHF
  • Buy property abroad with cash or a low loan-to-value mortgage.
  • Keep credit history healthy (as is regularly advocated these days)
  • Hedge your property bets by buying a property in somewhere like Turkey, with a foothold partially in and out of Europe

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