Most people tend to look no further than their bank or building society for a mortgage. For many people, it's simply the easiest option - they have been doing business with them for years, have a good relationship with the manager and feel entirely comfortable with what is a fairly risk-free approach. Other people are a bit more adventurous, taking it upon themselves to develop a good understanding of the lenders and products that are in the marketplace and relying on their own knowledge to actively choose a mortgage that meets their own set of criteria. Some people take things a step further still and get their mortgage in a foreign currency. It's risky, but in some cases the rewards can be worth it. We take a look at how it works, the potential benefits, the possibilities for disaster and what you can do to minimise the risk.

A basic foreign currency mortgage is really not all that complicated. Instead of lending you a mortgage in pounds Stirling, a bank advances you the money in an alternative mainstream currency, such as US dollars, Japanese Yen, French Francs, Euros or German marks.

You then convert this currency to pounds Stirling on the foreign exchange (usually through the same financial institution that lent you the money) and then use the British currency to buy your new property.

Your mortgage debt remains in the foreign currency and the interest rate you pay is also the one applicable to that currency, not the one denominated by the bank of England base rate. Your interest is charged in the foreign currency and when you need to make a repayment, you basically sell the appropriate amount of Stirling, which is then converted to the foreign currency to make the repayment.

The simple answer is that you can borrow money at a rate of interest lower than that which is normally available from lenders in the UK. At the moment the European Central Bank's interest rates are set at 4.75 percent, a full point lower than the rate set by the Bank of England. Meanwhile Japan's interest rates have fallen to zero. If the rate payable on your loan reflects this difference, then the difference in your repayments could be significant.

However, don't expect to be able to pay just the prevailing base rate in a country. Just as our lenders usually have Standard Variable Rates set more than one percent higher than base rates, so too will the rate you actually pay on your foreign currency loan be higher. The rate that you pay is normally a fixed percentage above what is known the LIBOR rate (the London Inter-Bank Offered Rate). Most lenders that offer foreign currency mortgages will charge you between one and two percent above the LIBOR rate.

Even so, getting your loan in a currency whose country has a lower cost of borrowing than the UK can save you thousands of pounds over the life of the loan. Consider this example:

A £150,000 loan repaid over 25 years at 6.75 percent would give you monthly repayments of approximately £1,050. If you borrowed the same mortgage in Japanese Yen, for instance, at a rate of 2 percent, then your monthly repayments would be around £650. This would be a staggering monthly saving of £400!

If everything goes according to plan, then there is scope for further savings to arise from favourable fluctuations in the exchange rate. If the pound climbs in value against the currency in which you took the loan, then you will need to spend fewer pounds to buy the same amount of foreign currency you initially borrowed. This means that in real terms, your mortgage has actually decreased!

Given the volatility of the foreign exchange markets, these fluctuations can be quite sizeable. At one point in 2000, the Euro had declined almost ten percent against Stirling in less than a year, meaning tens of thousands of pounds knocked off the total repayment bill for any lucky British residents who had earlier taken out a Euro mortgage.

Foreign currency mortgages are rightly described as being for risk-friendly speculators. As has already been mentioned, foreign exchange markets are notoriously volatile. Just as the value of Stirling can go up against the foreign currency of your choice, so too can it go down. And down. And down.

If the worst happens and Stirling crashes, or the foreign currency has a surge of strength, you can find your monthly repayments rising rapidly. If Stirling fell by 10 percent on a £150,000 loan borrowed in Euros at 5.5 percent, for instance, you could end up paying as much as £100 extra each month. And the more that you borrow, the greater your exposure to the risk and the more you could end up having to pay. Given the relative strength of Stirling at the moment, it would seem that this risk is a fairly real one.

Firstly, it is worth noting that most lenders will forward you an absolute maximum of 75 percent of the property value for a foreign currency mortgage. This protects them against fairly sizeable currency swings and the knock on effect that they have on your repayments. However, that is of little comfort to a borrower who is watch the monthly repayment bill grow and grow.

One way of minimising the damage that a falling pound can do is to make sure that the mortgage has a multi currency facility. This means that you are able to switch the currency in which repayments are made. You may well decide to switch back to pounds Stirling, but it may well be more appropriate to move to a different currency that is moving in a different direction against the currency in which you originally borrowed.

Say you originally borrowed in Dollars, but they are climbing against Stirling rather quickly. This means that the amount you owe is actually growing in Stirling terms rather quickly, as Stirling buys less Dollars. At the same time, the Euro is tumbling against both currencies - a fact which would normally have no effect on your loan. If you have the facility to switch your debt to the weakening currency - Euros - then you are effectively acting to further reduce the balance of your loan, as Stirling is able to buy more Euros for each pound you have at your disposal each month.

The tempting offer of a low interest rate can actually turn out to be something of a Trojan horse. Not only are you exposing yourself to a risk that can end up costing you a lot on a monthly basis, you are committing yourself to a venture that really takes a lot of time, observation and good judgement to be effective - things which are not that easy to ensure as an amateur borrower. Of course, you can leave it to a professional, but then you will be adding management charges to your costs and there's still no guarantee that they will be successful.

At the end of the day, there is the possibility to enjoy success on the foreign exchange and lower monthly repayments as a result of a reduced interest rate. But the bottom line is, only consider taking out a foreign currency mortgage if you are able and prepared to tolerate sizeable increases in the size of your loan.