Interest Rate Arbitrage - Pay off loan

Question

I am planning for interest rate arbitrage to pay off my education loan in India at 11.25% interest rate using a personal loan at 3.9% interest rate from an European country where I work drawing monthly income.

I know that there is EUR-INR Foreign exchange risk. But I am saving atleast 7% by paying off high interest rate loan back home.

I have below two options:

1. Make monthly payments as much as possible through foreign exchange transfer towards education loan in India. This will reduce foreign exchange risk due to averaging over few years, but the high interest rate @ 11.25% will be compounding.

2. Close this education loan in India using personal loan at 3.9% interest rate. I will try to close this low interest personal loan asap as there is no prepayment penalty. By this way, I have advantage of low interest rate but exposed to foreign exchange risk by transferring huge amount of money to India with current low conversion rate.

Please provide your valuable insights.

Thanks all.

Answer 1

If you get your income in the currency you have the new loan in, there is no exchange risk for the future.

Assuming that you are able to get and serve that loan, it reduces your cost, so go for it.

Yes, if the currency exchange rate changes the right way over the next years, you could have made a better deal - but consider it could also go the other way. If you really want to play this game, do it separately, by trading calls/puts on the currency exchange rate. See it as a separate and decoupled investment option.

Answer 2

If you plan to stay in Europe for some time, then you should match your income currency with your liability currency, and so should use the Euro loan to pay off the INR loan, thereby eliminating the currency risk that you currently bear every time you convert Euro into INR to pay down the loan. Plus, you have a much lower interest rate. So, do it !