Sophisticated borrowers who took out fashionable multicurrency mortgages have been caught out by the falling value of sterling, writes Elizabeth Colman.
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Demand for foreign-currency home loans surged last year as the pound rose to over $2.
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Borrowers can use these-loans to reduce the size of their mortgage by switching to a currency that is falling against the pound, preferably from a country that has a lower interest rate.
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Monthly repayments are made in sterling, which is then converted to the currency the mortgage is in. The difference in the exchange rate also goes towards paying off the mortgage.
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In November, the UK's largest manager of multi-currency mortgages, the ECU Group, converted its entire £900m mortgage book to US dollars.
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However, it is understood that ECU Group has been forced to switch the entire loan book back into sterling, resulting in a loss of 1.55% - or an increase of about £7,700 on a £500.000 mortgage.
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Melanie Bien of Savills Private Finance, a broker, said: "Foreign- currency mortgages are aimed at sophisticated high earners who want to cut their monthly mortgage payments by opting for low overseas interest rates. But it is important that you appreciate the risks involved.
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"Currency volatility is a real problem so it is important to take advice and ensure you know what you are getting into before taking out one of these mortgages."
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Trading in foreign currencies is not suitable for everyone and a client must ensure that they fully understand the risks involved before proceeding. A client should consult their financial adviser if they have any doubts about their suitability or the risks involved. Foreign exchange movements can be sudden and substantial. At no stage should a client expose themselves to the high risks of foreign currency trading if they are not able to afford the potential losses that could result from sizeable adverse currency movements.
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Specific additional risks for our currency management products are as follows:
Private client multi-currency loans
a) At no stage should a client be exposed to the high risks of foreign currency borrowings if they are unable to afford the potential losses that could result from adverse currency movements and the higher interest costs that would arise from having a larger loan.
b) A client’s lender will not tolerate an increase in the GBP value of a client’s loan above a predetermined level as a result of currency losses. The lender will agree a “Conversion Limit” with the client before a client takes out an ECU managed multi-currency loan. If the loan reaches or breaches its “Conversion Limit”, the lender may exercise its right, but not its obligation, to convert the loan back into GBP. However, a loan may be converted back into GBP at a worse level than the agreed Conversion Limit. This would mean that a client’s loan would increase by more than it would if it had been converted at the agreed Conversion Limit. Converting a loan back into GBP may result in a permanent increase in the GBP value of a client’s loan and the associated GBP interest costs.
c) The FSA risk warning is “Your home may be repossessed if you do not keep up repayments on a mortgage”.
Corporate loan management
a) At no stage should a client be exposed to the high risks of foreign currency borrowings if they are unable to afford the potential losses that could result from adverse currency movements and the higher interest costs that would arise from having a larger loan.
b) A client should be aware that their lender may not tolerate an increase in the base currency value of a loan if it exceeds a certain level and will have the right to convert the loan back into the base-currency.
Managed FX accounts
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b) A client should be aware that their lender will require additional margin to be paid on demand and will have the right to close any open positions if this additional margin is not promptly paid.
c) As with all margined products it is possible to incur significant losses and to lose more than the margin in the account at any one time.
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In respect of managing physical liabilities in foreign currencies, ECU trades the foreign exchange markets on a spot basis and issues switch instructions to lending banks on a spot basis. Neither of these activities is currently regulated by the Financial Services & Markets Act 2000 as they meet the "Commercial Purposes" test. Therefore you will not benefit from the protection of the Financial Services and Markets Act 2000.
However, if ECU instructs the Lender, or any prime broker or counterparty with whom ECU effects foreign exchange transactions, to conduct a switch by way of effecting an “option” or “futures” transaction for the Client’s account, such transactions may be considered to be an “investment of a specified kind” under the Financial Services and Markets Act 2000. Consequently, both the execution process provided by the Lender, or any prime broker or counterparty with whom ECU effects foreign exchange transactions, and the currency management services provided by ECU, as envisaged under this Agreement, may be considered to be regulated activities. In such instances, the Client may be required to sign additional risk warnings and the rules for the protection of investors under the Financial Services and Markets Act 2000 will apply.
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Sophisticated borrowers who took out fashionable multicurrency mortgages have been caught out by the falling value of sterling, writes Elizabeth Colman.
