Foreign currency mortgages are riskier than ordinary home loans denominated in sterling but, provided you call the exchange rates correctly, the savings on mortgages in other currencies can be enormous. Lorna Bourke explains.
While the decline in the US dollar over the past year has been bad news for investors in American shares, it has been good news for people with dollar mortgages.
Exchange rate movements over the past year will have reduced the debt on a £100,000 dollar-denominated mortgage to just £92,485, even before any capital repayments have been taken into account. Moreover, the interest rate is likely to have averaged around 2.5 per cent.
On January 12 I wrote of the weakening dollar: "The good news is that the United States is likely to be a bargain destination for holidays this year. But the bad news is that any recovery in the US share prices is likely to be cancelled out by a weak dollar. Estimates are for a 10 per cent drop in the dollar/euro rate."
In the event, the dollar went from approximate parity with the euro to $1.20. Its depreciation against the pound has been less marked because sterling has also fallen against the euro. But it is still significant. While £1 was worth $1.60 last December, it is now worth $1.73.
So what is the likelihood of further falls in the dollar? The US authorities are well known for making the rest of the world pay for the defence of the west by devaluing the dollar. This is what the American authorities did during the Vietnam War in the 1970s, when some of us can remember £1 touching $2.40.
They did it again in the early 1990s during the Gulf War; wand there is every reason to believe the same will happen this time too.
The latest forecast from the Organisation for Economic Co-operation and Development is for a deficit in the US current account balance of payments of 5 per cent of gross domestic product (GDP) this year, 5 per cent next year and 5.1 per cent in 2005. If the OECD is correct, these would be the largest deficits ever.
With the US presidential elections coming up in November next year, President Bush is unlikely to want consumers to have to tighten their belts.
As one currency expert put it: "The obvious conclusion is that the devaluation of the dollar has a long way to go."
At a recent Cato Think-tank monetary conference, experts predicted that the payments deficit problem would be solved by a continued rise in the euro to $1.60 by 2005. Only time will tell but virtually no one is predicting a strengthening of the dollar.
The ECU Group offers managed currency mortgages to people who do not wish to make their own currency decisions. Anyone who took out a £100,000 managed currency mortgage with ECU a year ago would have paid an average interest rate of just 2.79 per cent and would have seen the debt fall by 2.06 per cent.
This was achieved without taking the effects of any repayments of the capital into account. It was entirely due to movements in the basket of currencies managed by ECU.
Over the past three years, a £100,000 mortgage would have fallen to £84,200 and interest paid would have averaged 4.05 per cent. Over five years, the debt would have fallen to £75,000 and interest paid would have averaged 5.67 per cent.
ECU also offers currency mortgages for people who are prepared to make their own currency decisions. US dollar loans are the most popular, but others are available. The minimum mortgage is between £100,000 and £250,000.
Brokers able to arrange currency mortgages include Chase de Vere Mortgage Management (0800 358 5533), Savills Private Finance (020 1330 8568) and Charcol (020 7611 7000). The latter also offers sterling loans linked to the lower US Libor rate, currently around 2.5 per cent.
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. Past performance is not a reliable indicator of future performance.
Please note that for compliance purposes telephone calls may be recorded.
Specific additional risks for our currency management products are as follows:
Private client multi-currency mortgages
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
a) A Managed FX account is a margin account which is not suitable for everyone. A client must ensure that they fully understand the additional risks involved in margin trading.
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.
The UK Regulatory System
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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The views and foreign exchange and interest rate information in this website are based upon information from sources which we believe to be reliable but they are not guaranteed as to their accuracy or completeness. Expressions of opinion herein are subject to change without notice. Any contractual obligation between ECU and its clients will only be on the basis of undertakings contained in an ECU client agreement executed by both ECU and the client, as may be amended from time to time by ECU, and which may vary from any information contained herein. Products and services may be subject to material changes at any time from the information herein. ECU aims to ensure that all information herein is accurate at time of printing, but does not accept any responsibility for its accuracy.
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Foreign currency mortgages are riskier than ordinary home loans denominated in sterling but, provided you call the exchange rates correctly, the savings on mortgages in other currencies can be enormous. Lorna Bourke explains.
