With interest rates reaching 5 per cent and industry commentators predicting another increase this coming year, the cost of a mortgage is pushing some buyers out of the property equation all together. So what are the alternatives?
Although in a historical context interest rates may still be relatively low, borrowing money in sterling can cost significantly more than borrowing the same amount of money in a foreign currency.
Compared to other parts of the world, interest rates in the UK are soaring, with major currencies such as the euro, the Swiss franc and the Japanese yen charging considerably less.
Taking out a foreign currency mortgage is one way of benefiting from lower interest rates, although most people using this facility are likely to be people purchasing a property abroad.
However for the more adventurous borrower, taking out a foreign currency mortgage to purchase a property in the UK could offer huge savings.
Using a foreign currency mortgage to buy a property in the UK works by borrowing money in a currency other than sterling, whereby the debt on a UK property is charged at the prevailing rate of interest for that country rather than one determined by the Bank of England.
Borrowers are then able to make their monthly payments in sterling which is converted into the currency of the mortgage. It sounds relatively straightforward, so why aren’t more mortgage intermediaries advising their clients to finance their properties this way?
The risk
With a foreign currency mortgage, the debt is denominated in a currency other than sterling, so should that currency appreciate against the pound, it would rise in sterling terms. In addition, the low interest rates that motivate many borrowers to take out these mortgages in the first place are in no way certain to remain low.
James Cotton, mortgage specialist for London & Country, says: “There is a danger in getting a foreign currency mortgage for interest rate purpose reasons only. If you look at US interest rates, they are currently above UK Base Rates and stand at 5.29 per cent, whereas in 2001 they where cheap as chips at 1 per cent. However, the main risk comes from having a different currency mortgage to that of your income as there is an exchange rate risk. Luckily for people holding mortgages in US dollars, the currency has recently depreciated against the sterling.”
If you are a homeowner of a property abroad and your mortgage is in that country’s currency you will have a safeguard to some degree in the form of an asset which, if need be, could be sold in that currency. However, if your foreign currency mortgage is funding a UK residence, your repayments could increase to an extent whereby even selling your own home would not recoup the debt owed.
Ray Boulger, senior technical manager at John Charcol, refers to Black Wednesday – when sterling fell by 10 per cent after leaving the European exchange rate mechanism (ERM) in 1992 – as a lesson to be learned from.
Boulger explains: “When Britain was in the ERM, interest rates were directed by keeping in line with euro currencies, so that there were few currency fluctuations within the euro zone. Once we escaped the ERM, interest rates had to be pulled up to combat increasing inflation. This led to sterling falling, so people with foreign mortgages found it increasingly difficult to continue meeting their repayments.
“Although after two or three years sterling was back up and above the level it was while it was in the ERM, enabling borrowers to recover, for those who could not afford to maintain their foreign currency mortgages, lenders forced them to convert their mortgage loans back into sterling.”
Boulger says many people who are interested in foreign currency mortgages initially are attracted because of lower interest rates, but what is really important to consider is the currency value. Boulger suggests that clients interested in using a foreign currency mortgage use a multi-currency facility enabling them to transfer their loan from one currency to another at any given time.
He says: “Foreign currency mortgages in a single currency are madness, to commit yourself to. With a multi-currency facility you are giving yourself flexibility, which could include sterling.”
Multi-currency mortgages
A multi-currency mortgage works by enabling borrowers to transfer the debt of their mortgage into different currencies, allowing customers to even have their mortgage tied to several different currencies at the one time.
The aim is to have your mortgage in a weak currency or currencies which ideally have an interest rate lower than sterling. This would give the combined effect of capital reduction and interest rate saving.
Martin Wade, director at Mortgage Options, comments: “The purpose of a multi-currency mortgage is to erode the value of your mortgage, rather than to save on interest rates. To take advantage of this thought process most people will have an interest only mortgage, so the debt is reduced through currency exchanges. Any interest rate savings are a bonus and will further reduce a customer’s debt as they will usually pay the same amount each month until the debt is paid.”
To give an example of how multi-currency mortgages can erode the debt of a mortgage, suppose you have a £1 million mortgage which you switch into US dollars when the exchange rate is $1.80, leaving you with a mortgage of $1.8 million. Then suppose sterling strengthens so that it is worth $2 – if you then divided your mortgage by two your mortgage debt would now be reduced to £900,000.
As long as multi-currency mortgages do what they are supposed to do, it is no surprise that increasingly financially savvy borrowers are transferring their sterling mortgages into other currencies.
However, Boulger warns that in order to manage your own multi-currency mortgage a borrower would need to have a keen understanding of currency values and their forecasts if they wished to manage their own debt. Most people will find this too much stress even if they work in the market and will use a debt managing service that will give their bank instructions on where to transfer the mortgage.
Keeping informed
Figures from ECU, the currency debt manager, suggest that a client’s mortgage can be reduced by up to 40 per cent in 10 years, just by making interest only payments, through savings made keeping a client’s debt in currencies that are falling against the pound. On average ECU will switch a multi-currency mortgage 15 times a year.
In addition, although there is no guarantee that you will pay lower interest rates to those set by the Bank of England, over a 10-year period the average interest paid by ECU customers has been 4.37 per cent compared to UK interest rates which averaged a 6.94 per cent.
Cormac Naughten, director of private clients at ECU, says: “There are risks involved in using this type of mortgage, but it is a valuable product which can offer considerable savings and tax efficiency.
“We’ve been advised that under current UK tax legislation, for an individual borrowing against their main residence, on a multi-currency mortgage, neither the loan reduction or interest rate saving are currently liable to capital gains tax.”
However, despite the temptation to taking such a seemingly winning risk on a mortgage, the risks are steep. While loans can be reduced, conversely they can also be increased. Should they go too far in the wrong direction a lending bank will reserve the right to convert a client’s mortgage back into sterling and a client could be left with a mortgage 15 per cent more than the original amount.
Although Naughten concedes there can be considerable fluctuations to this type of mortgage, he also adds that this has not happened to an ECU customer since 1995 and that the 15 per cent set by banks is a safeguard should the mortgage loan go above the original amount that would make it unaffordable.
He says: “These mortgages appeal to professionals, City workers, property investors and other high income clients who can afford to take the risk should the loan increase 15 per cent. The private banks who provide these mortgages have adopted stringent lending criteria, so that if the mortgage is converted back into sterling and is higher than the original amount it will not adversely affect the client’s standard of living.”
Money makes money
Debt management services do not come cheap; ECU charges both a management and a performance fee to their multi-currency mortgage clients. With an annual management fee of around 1 per cent and a performance fee of 20 per cent of the combined interest rate saving and debt reduction.
Not only that but acquiring a multi-currency mortgage in the first place has a limited availability. Facilities tend to be only available through private banks such as HSBC, Vestec or Citibank. These lenders will only let you use a multi-currency facility if you are borrowing a minimum of £500,000 – rarely will they let you borrow less. In addition, the principle earner on the mortgage will have to have an income of at least £100,000 a year, and the loan-to-value (LTV) is usually between 65-75 per cent. The reason for this is that should the foreign currency appreciate against sterling, the lender needs an extra margin to secure the debt. Should the currency appreciate and the LTV rise to 80 per cent, the borrower will need to provide additional collateral or the lender may convert the mortgage loan back to sterling.
Client potential
Multi-currency mortgages are obviously a niche product and will not suit the vast majority of an intermediarie’s clients. However, for brokers with a large quantity of high net worth clients, the facility may be worth investigating, explains Cotton.
He adds: “Although multi-currency mortgages can allow individuals to pay a mortgage off more quickly than a conventional mortgage, advising a client on taking out such a scheme is a matter of making them aware of the potential risks rather than saying which mortgage will cost them the least.”
As intermediaries continue to look for ways to diversify their business, some intermediaries may feel that providing advice on such mortgages could benefit a large majority of their clients.
Boulger comments: “These are sophisticated products whereby a lot of clients seeking advice will already have a considerable understanding of how they work. In order to provide a full service of advice, brokers will need to be able to negotiate a competitive London Interbank Offered Rate (LIBOR) with lenders on behalf of their clients as there are no set products with multi-currency mortgages.”
Even so, despite a high level of specialist advice, ECU says that 80 per cent of their business is referred to them by brokers and that the multi-currency mortgage market is set to grow as people continue to look for ways of saving on their mortgage.
That said, like all successful money spinners, there are risks and only the wealthy can really afford the risks involved in such deals. Indeed, money can and does make money. Interestingly multi-currency mortgages are not advertised, but as Boulger points out, banks do not need to advertise these products as the people who are suitable for them tend to be aware of them anyway.
Even if the lending criteria on these mortgages was to relax a little, there would undoubtedly be the feeling that if you really wanted to make money this way, you should have entered into it 10 years ago. UK borrowers tend to be more conservative in their risk taking, with an increasing number opting for fixed rate mortgages in the face of higher and potentially rising interest rates.
It is absolutely imperative that people can figure out what they owe on their mortgage loan at any given time. Debt – especially that which is mortgage-related – is a contentious issue, especially if you are the one who advised a strategy that may have led your client there.
