How Some Investors are Paying Off Their Mortgages Without Lifting a Finger

Many investors prefer to buy property to hold, and others prefer to sell as soon as they can make a decent profit. Some prefer a bit of both to keep the cash flow going.

If your investment strategy is ‘buy and hold’ then one of the most important considerations is: how are you going to pay off the debt and realise profits? Investors generally do not want to pay interest on their mortgage borrowings for any longer than is necessary.

Many investors are relying on market conditions to keep property prices rising. After all they have risen at an average 7% per annum since records began over 35 years ago. The increase in equity over time should eventually reduce their debt levels when they do come to sell their property.

However some investors are starting to take a proactive approach in debt reduction. One of these approaches is the use of foreign currency mortgages.

Debt Reduction – The Smart Way

In simplistic terms, they switch their loan between various major currencies with the aim of reducing both the value of the debt and the interest paid on that debt. There are many advantages of doing this. Let us consider an example.

Let’s assume that an investor has a UK based property portfolio with an outstanding mortgage of £1 million. Let’s also assume that the rate of interest paid on the mortgage is 6% p.a giving an annual interest bill of £60,000.

There are many countries around the world where interest rates are lower than UK. For example, the one-year market rates (or BBA LIBOR rates) for some of the leading world economies are:

Sterling (£): 6.59%
US ($): 5.26%
Canada ($): 5.01%
Euro (€): 4.78%
Swiss Fr: 2.98%
Yen (Y): 1.1%

[Source: Financial Times 03 Sept 2007]

Suppose we decide to switch our Sterling loan to Yen at the exchange rate of 226.00 (i.e. £1 buys Y226 on the day). This gives rise to a Yen loan of Y0.226bn with interest rates around 1.1%.

Now let’s say the Yen weakens by 5% against Sterling. This makes the new exchange rate Y237.3:£1. At this point the loan is transferred back into sterling. The 5% movement results in the debt reducing from £1m to £950,000, or by £50,000 (as 5% of £1m is 50k). While the debt was held in Yen, the interest rates paid were not 6.59% but only 1.1%.

A few such favourable movements can reduce the debt considerably.

[NOTE: By the way, if you are thinking that you are already able to get mortgage at a rate lesser than 6.5% then think again - the real cost of borrowing is when you take all costs into account, including arrangement fees etc.]

But the question is: how do you switch your mortgage from a UK bank to a Japanese lender? The answer is: You do not.

How To Do It

Let’s assume that you have a few thousand pounds sitting in your savings account. Let’s say that your risk capital is £50K and you are happy to put this sum into a currency trading account. The fund managers will move the money all over the place with the objective of reducing your mortgage debt by 5% per year. If this works well then this should pay off your £1m mortgage in about 14 years.

But Wait, There Is Icing On The Cake

• In that time your property will probably have doubled in value (if property prices of the last 35 years are any indication).
• The gain of £1m made using foreign currency strategy will, most probably, be tax-free for most investors.
• However if it all goes horribly wrong then the loss is capped at your risk capital (i.e. £50,000, or 5% of £1m)

Advantages Of This Strategy

• There is no need to physically switch the entire debt to a new lender
• Any fees to fund managers are paid only on profits. If you do not make a profit then there are no fees to pay.
• There is no tax on profits for most investors
• Risk can be capped. E.g. your maximum risk is your risk capital, i.e. 5% (or £50k in our example).

But There Are Some Disadvantages Too

• You need some cash to get going (generally 5%). This cash, called margin funds, go into your trading account.
• You could loose some, or all, of this amount. That is why it is called risk capital. So don’t do this if you can’t afford to loose this capital.

Can you do it yourselves?

Yes, you can. After all, anyone can access information on currency exchange rates. However the DIY option is expensive, cumbersome and not recommended.

Also the currency lender will almost certainly charge you a set up fee for the facility. They will also charge commission on all currency transactions. In addition, any profits made are taxable at prevailing rates.

To keep your costs low you should use fund managers who do this for a living and will only get paid if you make a profit.

The key to success is to be in the right currencies at the right time. In other words, your debt should be in a weakening currency in order to succeed. That is yet another reason why you should use expertise rather than choosing the DIY route.

Is This Route For You?

It really depends on your risk tolerance level. It is certainly not for the faint hearted, or those who cannot afford to lose their risk capital. There are plenty of upsides but you should always consider the downsides. It is probably best to start small and increase your capital exposure with time.

So To Summarise, Here Is The Overall Process

• You keep your existing loans in place.
• You open an account with an FSA regulated broker specialising in currency switching.
• You put some money into this account. This is typically 5% of the nominal amount traded.
• Your broker trades on your behalf.
• Any benefits accrued as a result of currency movements and interest rate differentials are credited to your account.
• You can do whatever you want with this money. You can pay off the mortgage debt or take an exotic holiday – it’s your money and your choice.

[tags]foreign currency mortgage, property investing, debt reduction, pay off mortgage[/tags]