Vol.29 - Profiting From Your Property Loan

Profiting From Your Property Loan
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By Chris Cleary, Banner Japan K.K | October 6, 2005 | Comment on this article

For expatriates working in Japan, a property loan in Yen can give you a clear advantage over other-country based sources of finance. The interest rate you secure is likely to be several full percentage points lower than for a home-based loan (currently in the 1.6% p.a. range or better); in addition you regularise your obligations around the currency of your salary, and therefore leave yourself less open to the vagaries of exchange rates. Of course, you still have a loan, and have to repay it. This article examines how you can turn your method of repayment to further advantage.

If you choose to live abroad you can never fully eliminate foreign exchange risk. If you take out a Yen-based loan the amount you owe is denominated in Yen. While you earn in Yen you want the Yen to remain strong to boost your spending power. However at some point you would also like the Yen to weaken as this will reduce the size of the lump-sum you owe as expressed in your home-based currency. Will the Yen weaken? Not any time soon courtesy of Japan’s ongoing and massive trade surplus. However, a AAA currency rating must be reconciled eventually with a national credit rating four notches weaker, and Japan’s regional neighbours as well as its over-mature demographics will tip the logic of the weighting towards the debt side of the equation. The Yen will weaken, although there is no reason to think it will do so any time soon.

Qualification for a foreign currency loan is a little more stringent than for a domestic lending situation. Typically the lending set-up is that you earn here and in Yen; the property is in another country (not necessarily your country of nationality), and the lending bank is in a third country (why not in Japan? – the reasons are to do with assumptions and horizons and various other reasons). For the lending bank there is more risk involved as, if they have to foreclose on a delinquent lender, they are geographically and legally more distant than with a fully domestic situation, where the bank, the borrower and the property are in the same country and ideally just round the corner.

The equity you have to put down with a Yen loan is therefore likely to be higher than with a domestic borrowing situation, and typically in the 25-35% range. However you can ameliorate this requirement by the leveraging possibilities that a foreign based bank will accept – and accept gladly.

When the loan is made, a foreign-based bank will allow interest + principal repayment (normal set-up: “I + P”) or interest only. With interest only of course the bank will want to be reassured that the principal will be repaid at the end of the loan; the bank will therefore require a Repayment Vehicle (“I + RV”). This can be a lump sum investment or, if you do not have a lump sum, a regular contribution savings plan. The investment you make is legally assigned to the lending bank until it grows to the amount of the principal owed, or the end of the loan period. The modest leverage thus afforded can be quite dramatic in its profit potential and certainly goes a long way to rebalancing the dictated size of the initial equity.

To give a lump-sum example:

Borrow ¥20m.
Repayment (I+P) over 14 years: ¥131,000.
Repayment (I+RV) over 14 years: ¥27,000
Lump sum capital guaranteed investment (RV) over 14 years: ¥20m
Lump-sum value at different annual yields:
12%: ¥97.74m; 9% ¥66.83; 6% ¥45.22
End profit: 12%: ¥77.74; 9%: ¥46.83; 6%: ¥25.22.
Your risk? You have zero downside as the capital sum is guaranteed by a bank of at least AA-.

Or, if you do not have a lump sum much beyond your initial equity:
Start regular contribution plan with lender’s assumption of 6% growth and a 20% cushion on the target amount:
Target to ¥24m in 14 years @ 6% = (RV) ¥104,000/month.
End profit at 6% = ¥4m
End profit at 9% = ¥9.97m
End profit at 12% = ¥17.85m.
Your risk? The plan does not achieve any growth. Unlikely with the diversification available with modern plans and the benefits of cost averaging.
* above quotes net of all charges.

At the end of the loan period, or before if you choose to repay the loan, the investment reverts to you, minus the loan principal.

Finally, there are two safety-valves to a Yen mortgage on foreign property. The first is that it is switchable to another currency – typically to the currency where the property is located, and US$. Interest rates in Japan have been very very low for ten years. One day they will rise. Not any time soon as this will destroy the JGB market and the capital adequacy ratios of the banks and life-insurers. But they will eventually, and if they do, and there is a concomittant falling Yen scenario, they could rise swiftly. With a multi-currency mortgage you are not locked into Yen; and switching is free.

The other safety valve is that Yen mortgages do not have a prepayment penalty. You can pay them down whenever you wish, which gives you considerable flexibility in handling the mortgage and retrieving your assigned investment, on which you will in most scenarios be making a considerable profit.

Information on foreign currency loans, as well as lump sum and regular contribution repayment vehicles, is available from:

Chris Cleary
Director
Banner Japan K.K
Integrated Investments, Tax & Estate Planning Services

Further information on portable pension plans is available free from Banner Japan at:
+81 (0)3 5724-5100; www.bannerjapan.com ; questions@bannerjapan.com

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