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CURRENCY AND EXCHANGE RISK WHEN BUYING PROPERTY ABROAD

 

Buying property is the biggest financial transaction that most of us will ever make. Due to the large amounts of money involved, small differences in rates, commissions or payment schedules can make a big difference to your pocket.

If the current and/or future assets you are expecting to use for the property purchase and/or mortgage repayments are held in different currencies, financial planning becomes difficult. The challenges can be split into two main areas:

  1. Exchange rate risk: sudden changes in the markets could mean a very exchange rate, with the consequent impact on bottom-line figures.
  2. Price risk: the actual exchange rate you receive, commissions and/or transfer costs all make a difference to the total cost to you.

This article will look at both of these areas and explain with some straightforward examples how you can calculate different options and identify the best deal.

Exchange rate risk

Like most markets, the currency market is prone to periods of instability and readjustment. Just because the exchange rate between a pair of different currencies has been stable for many months, there is no reason to assume it will be the case tomorrow. For an idea of the scale of possible movement, just look at the South African Rand expressed in British Pounds below:

Large swings have the most immediate and obvious impact when taking about large sums of money.

For example, you agreed to buy a beautiful beach-side property in a new Cape Town development for 810,000 Rand in mid-2005 with a completion date for the purchase in Jan 2006. It may have cost GBP 64,800 when you agreed to buy the property, but GBP 72,900 in real money when you needed to complete the purchase.

In this example period the Rand weakened against the Pound. The opposite can take place, and you ‘win’ in the currency movement. However, many people don’t regard themselves to be currency traders and have a preference for certainty. So, what options do you have? :

  1. Transfer the whole amount today. Advantages: you lock in the current exchange rate and get certainty over the exchange rate. Disadvantages: you might not have all of the cash to make the transfer or the interest you earn in the foreign currency may be less than you are currently earning on the money.
  2. Buy a ‘forward contract’ to lock in an exchange rate. Advantages: you get a guaranteed rate in the future without having to pay all of money up-front. Disadvantages: there is a principle payment to make and you are obliged to complete on the deal and pay commissions.
  3. Buy an option to lock in an exchange rate. Advantages: you only need the amount the option costs to lock in an exchange rate. Disadvantages: you lose the amount the option costs whether you make a later trade or not.

Price risk

You will often see an exchange rate between two currencies on the news and in some exchange rate tables, online services, etc. This will be the ‘Interbank Rate’ and is more or less the level a couple of banks might use to calculate a trade with a value of more than a few million Pounds or tens of million Rand. In banks and bureau de change’s you will see exchange rates quoted with buy and sell prices. The difference (spread) between the two amounts is the margin of profit made by the provider.

Some people get surprised when they make a calculation on the basis of the rate they find in the newspaper and then find out their transfer has cost them a lot more. Typically, you will get the worst exchange rates in airports and bureau de change in tourist areas. Online providers sometimes have cheap or no costs for making the transfer, but then use an exchange rate with a large spread. High-street banks do not often offer very good deals when it comes to money transfer, often applying less favorable rates to their private customers that those they use with business customers. Usually the best deal you can get will be from a currency exchange specialist, although not all of them deal with small retail transactions.

You can break price risk into three different components:

  1. Spread – the difference between the Interbank exchange rate and the buy price you are quoted.
  2. Commission – the cost applied for the exchange, this will be a percentage of the transaction or a flat fee.
  3. Transfer costs – the cost applied to make the transfer out of the exchanged currency.

Most providers will not charge all of these elements, but it is important to take into account their impact when making a calculation. Let’s take an example: Willem works in London and is paying R 3,000 monthly to cover the mortgage on a property in Durban. He checks out a couple of providers (exchange rates are for example purposes only):

Interbank rate GBP/ZAR 14.11
Provider 1 will sell ZAR at 13.10 – GBP 229
Provider 2 will sell ZAR at 12.70 – GBP 236

Provider 1 looks like the best deal as Willem’s monthly cost to cover the R 3,000 payment would be GBP 229. But Provider 1 charges a GBP 10 transfer charge, which Provider 2 does not have, any additional charges. This small difference would make Provider 2 cheaper by GBP 3.

Some tips

  • Shop around
  • Make sure you understand when you need to exchange your money and make a plan to see how changes in rates could affect you
  • Talk to specialists: many will be willing to listen to your requirements and suggest how to best meet them on a non-obligation basis. Unlike high-street banks, they tend to have a more personal and results-oriented approach.

By Peter Filmer, Exchange4Free
We are Experts in the South African Rand. We offer the best rates, no commissions, no transfer fees and great advice. Get in touch!
Tel. UK: 0207 858 1039
Tel. International: +44 207 858 1039
http://www.exchange4free.co.uk


Posted 22Mar09