A denominated loan is the most common type of mortgage loan converted into foreign currency. In the loan agreement, its amount is expressed in the currency of the loan, for example in Swiss francs. However, the loan is paid to the borrower in USD at the exchange rate as of the date of launch. When deciding on a denominated loan, we do not really know what amount of USD the bank will pay us. It may be lower or higher than the one we requested.
Among the various types of loans available in banks, an important place in the loan offer is occupied by a mortgage. It is usually taken for the implementation of broadly understood housing goals.
The mortgage calculator is able to tell clients how much such liability will cost and what principal and interest installments the customer will pay during the loan period. The type of mortgage is a denominated loan. Let’s check what it actually consists of.
What is a denominated loan?
In bank offers, a denominated loan is nothing new. It has been around for years, but many bank customers are unable to answer the question of what it is. How can you explain the term “denominated loan”?
The definition indicates that in this case, we are dealing with a foreign currency loan, in which the amount of debt in a given foreign currency is calculated according to the currency buying rate that is in force on the day the loan agreement is signed with the borrower. At the same time, regardless of the currency in which the loan is denominated, installments are always repaid in USD.
Exchange rates are constantly changing, therefore loans denominated are risky. There is a real risk in their case that the amount of the loan paid out in national currency will prove insufficient, e.g. for the purchase of a specific property. The reverse situation may also occur – that the exchange rate will increase from the moment the loan agreement is signed, and as a result, the borrower will receive more funds in the national currency.
The specificity of a denominated loan is easier to understand if we look at an example. We assume that a loan of USD 100,000 denominated in USD is granted, and on the day of signing the loan agreement the purchase rate of the dollar by the bank is USD 4.20 / USD, while the selling rate is USD 4.30 / USD. The loan amount mentioned in the contract is 23,809.52 dollars (at the purchase rate), and the installment is around 238 dollars.
The installment on the day of launch is USD 1023.40 (at the selling rate), and the repayment of the entire liability on that day is USD 102,440. If the loan amount is USD 100,000, after denomination USD 23,809.52, and the loan is paid out in tranches, it may happen that these differences in the amount of funds paid will be more pronounced due to fluctuations in the exchange rate over a longer period of time.
If the dollar appreciates against the dollar, the tranche of the denominated loan paid in dollars may not be sufficient for the needs presented by the borrower.
Advantages and disadvantages of a denominated loan
A loan is risky and this risk level is its biggest drawback. You can say it’s a currency loan only for the brave. Exchange rates change unpredictably and dynamically, actually from day today. They affect the amount of the denominated loan.
As a result, it may happen that the amount paid out is too small to cover the costs related to the investment planned by the borrower. Customers who take out a denominated loan paid in tranches take an even greater risk. Spreading the loan disbursement over a few months increases the exchange rate risk – the differences between subsequent tranche disbursements can be very high.
Despite the existing risk, a denominated loan also has advantages. It may have a better interest rate than a regular loan in USD, and at the same time, the borrower may obtain a larger loan amount than in USD and a chance to pay off the debt faster.
Loan denominated in francs
If the bank grants a loan denominated in Swiss francs, its amount in USD is converted into CHF at the exchange rate on the day the loan agreement is prepared. The conversion takes place at the franc buying rate applicable on that day at the bank.
A loan denominated in CHF, which is paid out later, after signing the loan agreement, may have a higher or lower amount than the one indicated on the agreement.
Loan denominated in dollar
As in the case of a loan denominated in Swiss francs, the loan denominated in dollars is granted in such a way that its amount in dollars is converted into dollars at the exchange rate on the date of the loan agreement, but the loan is already disbursed at the exchange rate applicable on the day of withdrawal.
Denominated loan paid out in tranches
The payment of a loan denominated in tranches increases the risk of loss for the borrower. All because the disbursement of funds from the loan takes place gradually, for example, as the house is being built or the apartment is being renovated – this is the case when mortgage and construction loans are granted.
In the case of a loan denominated in tranches when signing a loan agreement, it is known in advance how much currency is available, but it is only at the last tranche that the customer finds out how much he actually borrowed in USD from the bank.
Generally, the longer the period between the moment of determining the amount of the loan in currency and the time of its final payment in USD, the greater the probability that the USD equivalent may be completely different than expected by the customer.
What is the difference between denominated and indexed credit?
We already know what a denominated loan is, but how is it different from an indexed loan? Are loans denominated and indexed the same loans? Although there are similarities between them, it cannot be said that they are the same.
An indexed loan is another type of foreign currency loan that is converted from USD to foreign currency at the time of its launch, i.e. the payment of money to the borrower. At the stage of concluding the contract in a denominated loan, the customer immediately knows the amount of debt in a foreign currency, and the indexed loan only contains information about the amount of dollars to be repaid.
An indexed loan will guarantee the customer, e.g. purchase of the real estate, but part of the money may be paid to him at an unfavorable rate. With this type of loan, a lower exchange rate will not result in a smaller amount of money being paid out, but the customer will have less money in the currency to pay.