A report by accountancy firm Grant Thornton reveals that 1.2 million Britons now own homes abroad. As a result, many borrowers have an increased awareness of foreign interest rates and appreciate that UK rates are higher than in many other parts of the world. With UK interest rates at 5.5% and pundits suggesting they will hit 6% this year, an increasing number of clients are looking to borrow against their UK properties using foreign currency mortgages.
This allows them to borrow in a currency other than sterling with interest charged at the prevailing rate for that currency rather than UK rates. Interest payments are then made in sterling. Many choose low interest currencies such as Japanese yen or Swiss francs with interest rates of 0.5% and 2.25% respectively. If it is possible to borrow at these rates against UK property, why aren’t more brokers involved?
For those with long memories this may sound familiar. Many people took out currency mortgages in the late 1980s and early 1990s, sometimes with disastrous consequences. The preferred vehicles for many were single-currency loans in yen or Swiss francs as these seemed to offer low interest rates compared with double-digit rates in the UK.
As a currency mortgage is denominated in a currency other than sterling, should this appreciate against the pound, the sterling equivalent of the debt will rise.
Unfortunately, when sterling famously left the European Exchange Rate Mechan- ism on Black Wednesday in 1992, borrowers saw the pound weaken considerably, causing the sterling equivalents of their mortgages to rise.
For example, £1m borrowed in yen in 1992 almost doubled to £1.9m by 1995.
While many who are interested in currency mortgages are initially attracted by lower interest rates, over the past 18 years savvy clients and their brokers have seen that the key to unlocking these benefits lies in currency fluctuations. They have used these fluctuations to reduce the size of debts by using professionally managed multi-currency mortgages.
A multi-currency mortgage allows a borrower the flexibility to switch their mortgages between currencies such as US dollars, Swiss francs, yen, euros and sterling. This offers benefits in addition to interest savings.
If a mortgage is switched into a currency that weakens against the pound, this will reduce the sterling value of the mortgage without the borrower having to make repayments themselves. For example, if you convert a £1m mortgage into US dollars when each pound is equal to $1.80, this gives you a $1.8m mortgage. If the pound strengthens until it is worth $2, if you convert your dollar mortgage back into sterling it would be reduced to £900,000.
For most people, the volatility of the foreign exchange markets and the need for monitoring means managing currency risk is beyond their resources, so they employ specialist currency management firms. A currency mortgage manager’s role is to place mortgages in currencies that are expected to weaken or remain stable against the pound, consistent with an interest rate advantage where possible.
Figures from one UK currency mortgage manager show it has reduced a client’s mortgage by some 40% over the past 10 years through currency fluctuations alone. This benefit is amplified by the tax treatment of the product. For individuals or trustees borrowing against their main residences, this loan reduction has not been liable to Capital Gains Tax.
It sounds simple but what else do brokers need to know? Multi-currency mortgages are not available from high street lenders. They are only available from about a dozen private banks such as HSBC, Investec, Citigroup, Kaupthing Singer & Friedlander and Kleinwort Benson.
Loans tend to be on a five-year interest-only basis. Interest is payable monthly or quarterly in arrears at the prevailing LIBOR rate for whichever currency the loan is denominated in plus a lender’s margin of between 1% and 2%.
The entry criteria are rigorous. As well as a minimum income of £100,000, clients require a minimum loan size of £250,000 with a maximum gearing level of 70%. Many lenders will not consider loans below £500,000.
Moreover, as currency mortgages are often for large amounts, lenders follow traditional underwriting practices with no online decisions or au-tomated valuation models.
Private banks generally charge clients arrangement fees of 0.5%, split with introducing brokers.
Also, clients pay legal and valuation fees. Currency managers typically charge annual management fees of 1% of the value of the mortgage and performance fees of 20% of the profit made for clients.
They also often pay brokers a share of the management charge once a loan has been under management for a specified time.
The key thing about advising on managed currency mortgages is ensuring that customers understand that using currency managers does not remove all risks.
Lenders put in place a conversion limit which is typically 15% above the original loan size. If this is breached, they can convert the loan back into sterling. This would leave a client with a 15% larger loan on which they would then be paying sterling interest rates.
Currency managers and banks usually wish to meet clients to assess suitability, explain products and ensure they understand the risks.
So multi-currency mortgages are not suitable for all clients. They are popular among high income, financially sophisticated borrowers such as City workers and property investors. Brokers looking to attract more of these clients should consider offering managed currency mortgages.
Arranging a currency mortgage is more expensive at the outset for a client and more time consuming for a broker. But they mean that a client could have paid off the interest-only loans they took out in the late 1980s in full without making a single capital repayment.
Many would say they and their brokers have been well rewarded for the extra initial effort and cost involved. cormac naughten head of private clients, ECU Group