ECU IN THE MEDIA
Wall Street Journal - August 2002
A Foreign-Currency Bet on Your home
A Foreign-Currency Bet on Your home
Playing exchange markets with your mortgage holds risks but can save. Jo Wrighton explains
Mr. Fletcher declines to give the total value of his loan but says he is benefiting from lower U.S. interest rates, around 3% monthly compared to the 5% on a sterling loan. He also has gained from the pound's rise against the dollar, which has reduced his mortgage by 5%.
"Over the last three months, I've come out a winner," says the 44-year-old American, who has lived in the U.K. for the past nine years. He says he is also happy to be able to match his income, which is paid in dollars, with dollar-denominated mortgage expenses.
Foreign-currency mortgages - which allow individuals to borrow currencies that offer lower interest rates, such as the U.S. dollar, yen and Swiss franc - are increasingly popular. Deutsche Bank in Frankfurt, for example, estimates that 10% of all loans to its wealthy private clients are now denominated in a currency other than the euro, mainly the Swiss franc and yen.
Foreign-currency mortgages have one big advantage: If your base currency, say euros or pounds, climbs against the currency in which your loan is denominated, the size of the mortgage (measured in your home currency) decreases. The ECU Group, a London-based company that specializes in managing foreign-currency mortgages, estimates that from 1988 to the end of 2001, it reduced the effective size of a £100,000 (Euro56,274) mortgage to £63,640 and lowered the average interest rate on that mortgage to about 6% from 9.8%. That's before the ECU Group's performance fee of 15% of money saved through debt and interest-rate reduction.
But beware: The risks of foreign-currency mortgages are high if exchange rates move against you. Say an individual based in the euro zone takes out a dollar mortgage at an exchange rate of 98 U.S. cents to the euro, and the common currency falls to 88 cents. That effectively increases the size of the loan by 10%. "This is a market full of pitfalls and hazards," says Marcus Gregson, chief executive of HSBC Republic Bank in London. "Taking out a foreign-currency mortgage is almost an investment play, like buying an overseas stock. "
Because of the risks involved, banks that offer such mortgages attach all kinds of conditions to them. For instance, Deutsche Bank only lends foreign currency to private clients who have a "sound knowledge of the interest-rate and foreign-exchange markets and an expectation of where these markets are headed in the future," says a spokesperson. The bank also demands a hefty 20% additional collateral against the loan.
Many banks will only lend up to 70% of the value of the property in a foreign currency. Some, such as Singer & Friedlander in London, also require the borrower to re-denominate the mortgage in his or her domestic currency if exchange rates move too far against them. If the sterling-equivalent of the mortgage rises to 80% of the value of the property, the bank will convert the loan back to sterling. That puts the borrower in the unfortunate position of having to realize his loss and pay higher sterling interest rates. "It is possible for borrowers to lose a lot of money if exchange rates go against them," says Richard McAdam, mortgage specialist at Singer & Friedlander.
Other banks, such as Riggs Bank in London, only lend to individuals who have income or significant assets in the currency they want to borrow in. The bank will lend up to three times an individual's income with a minimum loan size of £250,000. The average foreign-currency loan at the bank is around £1 million, says Darren Arman, Riggs's director of mortgage lending.
Exactly how much you'll pay for a foreign-currency mortgage varies from bank to bank. But expect monthly interest payments to be 1 percentage point to 1.7 percentage points above the Libor rate of the currency you are borrowing in, depending on your net worth and the size of your down payment. Libor, or London Interbank Offered Rate, is that which big banks in London charge one another for loans.
Some advisors recommend borrowers take out short-term contracts of one-to-six months so that they can easily switch out of a currency if its starts to move against them. Look for banks that don't charge fees to switch from one currency to another; they can be as much as £150 a shot.
Which currency you borrow in depends on your outlook for that currency. Ideally, you want a mortgage in a currency you expect will fall against your base currency. For euro-based investors, for example, the outlook looks good for loans in most of the major currencies, foreign-exchange strategists say. "Over the last couple of years the euro has been undervalued," says Rebecca Patterson, a currency strategist at J.P. Morgan in New York. 'We think it will go back to fair value." While acknowledging that forecasting long-term currency movements is notoriously difficult, the bank projects the euro to rise against the dollar, yen, pound and Swiss franc over the next five years.
Shahab Jalinoos, a currency strategist at UBS Warburg in London, agrees that over the short term the euro is likely to strengthen against other major currencies. A year from now, he sees the euro rising to $1.15 from about 98 U.S. cents now; to 126.50 yen, from its current 116.25 yen; and to 1.52 Swiss francs from about 1.47. However, over the next five to 10 years, the dollar could rebound, Mr. Jalinoos cautions. "There are many people who think the U.S. has a structural-productivity advantage for reasons such as its flexible labour markets," he says. "That means that U.S.-growth potential would be higher than in the euro zone."
A final word to the wise: Currency markets, like stock markets, are extremely hard to predict. When Mr. Fletcher told his neighbour, an exchange-rate specialist, of his plans to take out a dollar mortgage back in May, he was told his timing was all wrong. But so far, a strong pound and weak dollar - has proved the expert wrong.
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