How a mortgage raises or cuts the return on your own money, with a hypothetical stress test, break-even rate, loan-to-value, cash-flow and currency risk.
A mortgage can make a property investment look much better than a deposit. It can also turn a small price fall into a large loss of your own money. This article explains how leverage works, with a hypothetical stress test, and what to watch: the interest rate, loan-to-value, cash flow and currency. It belongs to the series that starts with property or a bank deposit: which is more profitable. For the lending side, see mortgages for non-residents and a mortgage in your own country against property abroad.
What leverage does
With a mortgage you buy a larger asset with less of your own money. The return on your own money, the equity, then depends on three things: what the property earns, what the loan costs, and how much you borrowed. If the property earns more than the loan costs, leverage raises your return. If it earns less, leverage cuts it. Because the loan is fixed, gains and losses on the price fall on a smaller amount of your own money.
A hypothetical example
This is an illustration with round numbers. It is not a forecast, an offer or market data. It ignores purchase costs and mortgage fees, which would worsen every result.
A flat costs EUR 200,000 and nets EUR 4,400 a year after costs and tax (net yield 2.2%, see the yield bridge). Assume the price rises 2% a year, or EUR 4,000. The property earns EUR 8,400 a year, or 4.2% of its price.
- No loan. Your equity is EUR 200,000 and the return is 4.2%.
- Half borrowed. A loan of EUR 100,000 at 4% interest only costs EUR 4,000 a year. Your equity is EUR 100,000 and you keep EUR 4,400, a return of 4.4%. Leverage helped a little, because 4% is just below 4.2%.
- Rate of 5.5%. Interest is EUR 5,500, you keep EUR 2,900, a return of 2.9%. Leverage now hurts.
- No price growth. The property earns only EUR 4,400, or 2.2%. At a 4% loan you keep EUR 400 on EUR 100,000, a return of 0.4%, against 2.2% without a loan.
The break-even rate
The break-even rate is the loan rate at which leverage neither helps nor hurts: the property's return on its price. In the example it is 4.2% if prices grow 2% a year, and 2.2% with no price growth. If your loan costs more than that, borrowing lowers your return. Note that the rate is the all-in cost, including fees, and that for a variable-rate loan it can change. The comparison with a deposit changes too: a loan that costs 4% while a deposit earns 2.4% after tax means you pay more than you earn on savings.
Stress test: a price fall
Assume prices fall 10% in a year, from EUR 200,000 to EUR 180,000, and ignore rent for simplicity.
- No loan. You lose EUR 20,000 of EUR 200,000, which is 10%.
- With a EUR 100,000 loan. You still owe EUR 100,000. Your equity falls from EUR 100,000 to EUR 80,000, a loss of 20%, twice as large in percentage terms.
Loan-to-value (LTV) is the loan divided by the property value. It started at 50% and is now about 55.6%. A higher LTV leaves less margin. A bank may ask for more collateral or a faster repayment if the value falls much, depending on the contract; read this clause. A forced sale in a weak market tends to be at a discount.
Stress test: the interest rate
Interest-rate sensitivity depends on the loan type. With a variable rate or a fixed period that ends, a rise in rates passes straight into your payment. In the example, a rise from 4% to 5.5% on EUR 100,000 adds EUR 1,500 a year. A larger loan multiplies the effect. Ask what happens at the end of the fixed period, and whether early repayment has a fee.
Cash-flow risk
A mortgage is paid in cash every month, even when the flat stands empty. In the example, repaying the EUR 100,000 over 25 years at 4% as an annuity takes about EUR 6,300 a year. The net rent is EUR 4,400, so you fund about EUR 1,900 a year yourself, and more in a vacant year. Interest-only loans have lower payments but the principal remains due. Hold a reserve for several months of payments.
Currency mismatch
Borrowing in one currency while your income and the rent are in another adds a second risk. For example, a resident with income in zloty who borrows in euro owes a fixed amount of euro. If the euro becomes 10% more expensive in zloty, the loan costs 10% more zloty, whatever the property does. Match the currency of the loan to the currency of the income that pays it where you can, and see currency and payment for overseas buyers. Some foreign banks lend to non-residents only in the local currency, and in some countries, banks at home do not accept property abroad as collateral. We did not confirm rates and rules for every country; check them.
Other risks
- The bank may revalue the property or change its terms at refinancing.
- You may not obtain a loan at all as a non-resident, or only with a larger down payment.
- A loan secured on your home to buy another property puts your home at risk.
- Your own income may fall, or you may lose a job.
When no loan is the better choice
- You would pay more in interest than the property earns.
- The cash flow does not work in a vacant year.
- The loan is in a currency you do not earn.
- The property is your only large asset.
- You cannot hold a reserve.
A deposit does not have this problem, but it has its own: inflation and tax, see deposit rates, inflation and real return.
FAQ
Does a mortgage always increase the return? No. Only if the property's return on its price is higher than the all-in cost of the loan. Otherwise it lowers it.
What is a safe LTV? There is no single figure. A lower LTV leaves more margin if prices fall. Banks set their own limits, often lower for non-residents.
Is interest tax deductible? It depends on the country and on whether the property is let or lived in. Check with a local tax adviser.
Can I borrow at home against my own flat to buy abroad? Sometimes. It brings the risk to your home. See the article on a mortgage in your country against property abroad.
Should I repay the loan early? That depends on the loan rate, any fee and what else the money could earn. Compare after tax.
How we help
We are a trilingual platform that finds properties and coordinates independent local lawyers and tax advisers. This text is informational and is not legal, tax or investment advice, and past performance does not guarantee future results. All numbers in the examples are hypothetical; ask the lender for the real terms and a qualified adviser about your case.