Investment Finance

This page examines the different financial mechanisms available to the property investor.

When considering a medium or long term investment, mortgages are an extremely efficient mechanism for the completion of the purchase when the property has been finished.

In financial terms the process of borrowing funds to purchase property is often described as GEARING. When a property is highly geared this simply means that there is a large mortgage secured against the asset.

For example a property valued at 100,000 EUR with a 70,000 EUR mortgage, i.e.70% loan to valuation, would be described as highly geared, whilst a property with a 25% loan to valuation i.e. 25,000 EUR is low geared.

There are many advantages in "gearing" an investment and principally these are:

  • Allows financing when the investor does not have enough liquid funds.
  • Avoids tying up significant cash into one investment therefore allowing further investments to be made simultaneously.
  • It is easier on cash flow to fund the mortgage repayments than to fund the initial purchase price.
  • The ability to take advantage of different interest rates in differing countries.
  • The ability to take advantage of specific mortgage products to reduce risk such as interest only and fixed rates. Possibility of tax advantages depending on the country.
  • Negates exchange rate risks and differences upon sale.

    The main disadvantages for gearing are:

  • The investor must finance the mortgage repayments.
  • Financing may not yet be available in some countries for non residents.
  • The investor may need to demonstrate their ability to repay the loan.

    When considering Mortgages and Gearing it is important to consider all the options available, that is to say that it may not be the best option to look for a mortgage in the country in which the investment is being purchased.

    For example if the interest rates are very high in that particular country and there is another property in another country with low interest rates, then logically it would be more advisable to borrow where the interest rates are lower. In this respect it is always advisable to speak with a professional finance consultant who has experience in the countries you are considering investing in.

    Mortgage Products

    Capital and Interest

    This is the standard mortgage product throughout the world.

    The loan capital is repaid each month on an increasing basis over the specified term. The loan interest is also paid monthly but on a decreasing basis as the debt reduces each month.

    For example:

  • Over 25 years a 200,000 EUR mortgage at 4.5% would cost 1,111.66 EUR.
  • In year 1 the monthly repayment is made up of 361.66 EUR capital and 750.00 EUR interest.
  • By year 24 the monthly repayment is made up of 1,058.87 EUR capital and 52.79 EUR interest.

    Interest only

    Only the interest on the loan is paid each month, the capital remains constant.

    It is assumed that the property will be sold at the end of the mortgage term in order to repay the loan or there is another mechanism in place to pay off the loan such as a pension.

    The attraction of this type of loan is the lower monthly payment, using the example above EUR 200,000 gives a monthly repayment of EUR 750.00.

    Low start capital and interest

    This is a variation on the capital and interest mortgage where the amount of capital paid at the onset of the mortgage is lower than normal. Then each year the capital repaid element of the mortgage will increase by a minimal percentage say 2%. Again using the example above a 200, 000 EUR loan would give a monthly repayment of 934.80 EUR.

    Considering an overseas mortgage?

    As a start point it is always worth investigating the financing options available for the country in which the investment is situated. In this way the risk of exchange risks is immediately removed. This is the risk that upon sale the value of the asset will have decreased compared to the value of the loan.

    Example:

  • A property is purchased for 200,000 EUR using an interest only sterling mortgage of 96,000.
  • This represents 70% of 200,000 EUR = 140,000 EUR, exchanged into GBP at 1.45 = 96,000.
  • Upon sale after 5 years the property has grown in value to EUR 322,000 which if exchanged back into GBP at the original rate would be 222,000 GBP leaving a profit of 126,00 GBP after repaying the mortgage.
  • However exchange rates had altered to 1.95 which means the 322,000 EUR when converted back to GBP is 165,000 GBP, after repaying the mortgage of 96,000 GBP leaves a profit of 69,000 GBP.
  • A loss of 57,000 GBP compared to the exchange rates at the time of investment.
  • This can be avoided if the mortgage were in the same currency as the investment then any exchange rate movement will affect both the asset value AND the mortgage value.
  • It should also be remembered that if exchange rates were to move in the opposite direction significant exchange profits could occur.

    In addition to financing through a mortgage it is also possible to fund your investment using Equity Release and alternative finance mechanisms.