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The Sunday Business - December 2003

Fair exchange is no robbery

If you want to reduce your mortgage and pay below the going interest rate, you could consider a multi-currency loan. Jenne Mannion investigates

If you want to reduce your mortgage and pay below the going interest rate, you could consider a multi-currency loan. Such schemes are available for interest-only mortgages and aim to reduce the capital value of debt in sterling, by taking advantages of exchange rate movements. The ECU Group, a subsidiary of ED &F Man, is the UK's largest established currency mortgage manager. Cormac Naughten, head of private clients explains; "If you borrow £1m in yen when sterling is worth 180 yen, then your loan will become 180m yen. If the pound then strengthens so that it is now worth 200 yen when you convert the 180 yen back into sterling at the new rate of 200 yen the loan has been reduced to £900,000."

Multi-currency mortgages also access lower interest rates. The UK base rate is low, but there are still savings to be made in foreign currencies.

The yen London Interbank Offered Rate (Libor) is 0.1%. Elsewhere, short-term Libor rates are 0.25% on Swiss francs, 1.1% on the dollar and 2.1% on the euro. In addition, lending banks will charge a margin of 1.25%-2% above Libor.

Unless a client has considerable knowledge of currency markets, they will need to appoint a currency manager such as ECU. The manager arranges the facility with leading private banks such as HSBC Republic. It then decides which currencies to move into on a discretionary basis. For this is charges a yearly management fee on a sliding scale starting at 1% for a mortgage of £150,000 down to 0.25% on £10m or more, This charge can be offset against a performance fee.

Naughten Stresses that multi currency mortgages are not for everyone: "These types of loans are only suitable for financially sophisticated borrowers."

Whether you are taking control yourself or the loan is under the charge of a specialist manager, borrowers can easily stand to lose if foreign currencies move against them. Consequently, ECU's lending banks have narrow criteria for the clients it will accept. They must have a loan value of less than 65%. The minimum size loan starts at £100,000, but the average starting loan tends to be closer to £500,000. And clients must earn more than £75,000 a year at a maximum income multiple of three times although this is relaxed for loans in excess of £500,000 Naughten says clients must be allowed to withstand an increase of up to 20% in the value of their loans. The lending banks have the right to automatically convert the loan back into sterling if it increases by 10% - 15%, breaching what is known as the conversion limit. ECU has developed an array of risk management controls since 1995 and has not had a client breach a conversion limit since that time.

This does not mean it could not happen and Naughten adds that from 1992 to 1995 some clients were forced to withdraw from the programme with sizeable loan increases.

But if you take this additional risk, the benefits of managed currency mortgages can be substantial. ECU's audited figures for the past eight years up to 30 June 2003 show that almost 45% has been wiped off the value of client loans through currency switching with the figure rising to 79% if you also include the interest rate saving. Since 1988, the combined benefits of the programme have allowed borrowers to pay off in full loans taken out in the late 1980s.

These loan reductions are not subject to capital gains tax if the loan is secured against the main place of residence.
For those happy to take control of their currency switching, specialist mortgage brokers such as Savills Private Finance and Charcol Online can also shop around for the best deals.

But Ray Boulger, senior technical director at Charcol Online, warns these are only for those with knowledge of foreign currency markets.

"Back in the late 1980s when interest rates were in the double digits, there were substantial savings to be made. Nowadays interest rates are so low in the UK that is not the case."

"It requires taking a lot of risk and stress to save just a small amount," Bolger says. Simon Jones, director at Savills Private Finance, adds: "With currency loans you can lose 2, 3 or 4% overnight if you get it wrong."

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I have read and understand Risk Warnings.

Foreign exchange movements can be sudden and substantial. At no stage should you expose yourself to the high risks of foreign currency exposures if you are not able to afford the potential losses that could result from sizeable adverse currency movements and the higher interest rate servicing costs that would be required of you in the event of your having a larger debt.

Denominating debt in foreign currencies may not be suitable for you. Changes in the exchange rate may increase the sterling equivalent of your debt. Your lender will not tolerate too great an increase in the sterling equivalent of your debt as a result of currency losses and may opt to convert your debt back into sterling at a predetermined level. This may result in a permanent increase in the sterling equivalent of your debt which is not fully compensated for by any other benefits derived during the course of The ECU Group plc's discretionary currency debt management services. In this event, you could be left paying UK interest rates on a larger amount of sterling debt than that you originally borrowed. Your home may be repossessed if you do not keep up repayments on your mortgage.

Your lending bank sets a 'Conversion Limit' at which level they have the right to convert your managed multi-currency mortgage back into sterling to prevent further currency losses. It is important to understand that this is a right of your lending bank and not an obligation and that if they do not act promptly to convert your loan back into sterling when your Conversion Limit is reached, your loan could increase by more than that specified by your Conversion Limit.

ECU may from time to time transfer your loan into foreign currencies with higher interest rates than sterling with the objective of achieving a debt reduction in that currency.

Sterling interest rates are subject to change and the differential between sterling interest rates and the interest rates of other foreign currencies will fluctuate.

Suitability
The markets or financial instruments discussed herein may not be suitable for all investors and investors must make their own investment or participation decisions using their own independent advisors as they believe necessary and based upon their specific financial situation and investment objectives. Past performance is not a reliable indicator of future performance, and should not therefore form the basis of a decision whether or not to buy or sell any investments or financial instruments or to participate in any particular trading strategy mentioned herein.

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The ECU Group plc ("ECU") is authorised and regulated by the Financial Services Authority.

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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