If you had put a £1m mortgage into US dollars at the start of the year and left it without making a single payment, then thanks to the falling dollar that mortgage would have decreased in value by more than £70,000, writes Elaine Moore.
Such is the beauty of foreign currency mortgages, and the reason that a growing number of high-net- worth individuals are employing them. If you back the right currency, you can significantly reduce the capital value of your debt.
With the pound at its strongest against the dollar for more than a quarter of a century, multicurrency mortgage specialist ECU Group has converted its entire loan book into US dollars.
Cormac Naughten, director, says ECU Group expects the dollar to weaken even further against sterling.
But rather than convert a loan into a currency you think has hit rock bottom, the way to benefit from foreign currency-denominated loans is to catch the currency on its way down, says Ray Boulger of John Charcol mortgage brokers.
Foreign currency mortgages change the underlying currency of your mortgage loan to a different mainstream currency such as US dollars, Japanese yen or euros. Monthly repayments are made by you in sterling, which is then converted to the currency the mortgage is in and used to pay it off.
Loans managed by a debt manager can be switched regularly between currencies such as the pound, dollar, Canadian dollar, Swiss franc and euro, based on macroeconomic views.
There are two ways to benefit from doing this. First, if the interest rate of the country whose currency you use is lower than the UK’s, which is currently 5.75 per cent, you will pay less interest when borrowing in that currency.
In the late 1980s, foreign currency loans were a more regularly-used financial product, in part because UK interest rates had reached nearly 15 per cent by the end of 1989, and were higher than those in most other western countries.
However, the UK’s exit from the Exchange Rate Mechanism in 1992 meant many of those with multi-currency mortgages were automatically forced back into sterling and lost money.
Although this is not a fear of today’s borrowers, Naughten says that lower interest rates are still not the primary motive for choosing a currency mortgage. Fluctuations in a currency can effectively erase gains made from a lower interest rate in a single day. Instead, the main driver is loan reduction through currency fluctuation.
To take the example of the £1m mortgage converted to US dollars again: imagine converting this from sterling to US dollars when the exchange rate is $1.80 to the pound. The loan would become $1.8m.
If the dollar then fell against the pound and the exchange rate became $2 to every pound then that $1.8m loan would become £900,000. Some £100,000 would have been knocked off the value of the loan, purely through exchange rate movements.
If you are interested in taking out this sort of loan, specialist banks such as Singer & Friedlander Investment Management and Kleinwort Benson can arrange them. Most will only take on large loans of £1m or more and require 75 per cent loan-to-value to provide a buffer.
Melanie Bien at Savills Private Finance says that although foreign currency mortgages are growing in popularity, they are really only suited to sophisticated borrowers.
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 provision of the information in this web site does not constitute an offer of securities to any person in the United States or to any U.S. Person as such term is defined under the Securities Act of 1933, as amended. The information contained in this site about ECU Group and/or any of its affiliates is not directed to any person in the United States. Funds referred to herein are neither registered under the Securities Act 1933 of the USA, nor are they registered under the Investment Company Act of 1940. Consequently, they cannot be offered for sale or be sold in the USA, its territories, possessions or protectorates under its jurisdiction, nor to nationals, citizens or residents in any of those areas.
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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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If you had put a £1m mortgage into US dollars at the start of the year and left it without making a single payment, then thanks to the falling dollar that mortgage would have decreased in value by more than £70,000, writes Elaine Moore.
