Foreign Currency FX Loan

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  Definitions                                                                           FX Loans: Five important considerations                                                                  FX loans: know what you borrow
                                                                                                                                                                                                Loans denominated in Euros, Dollars, Swiss Francs or ano-
                                                                                       A foreign exchange loan is a risky product. The best way to                                              ther foreign currency often seem attractive, as interest rates
   What is an exchange rate?                                                           avoid the risks is taking a loan in local currency. If you do                                            are usually lower than loans in your local currency. However,
   An exchange rate is the price you pay for a foreign currency.                       decide to take a foreign exchange loan, do consider the                                                  these loans are risky: your monthly payments can increase
   Exchange rates are affected by several aspects out of your                          following:                                                                                               when the exchange rate changes.
   direct control, like money supply, trade balance, inflation,                                                                                                                                  Are you considering taking a foreign exchange loan? Please
   speculation. These exchange rates are unpredictable. The
   number of Leu needed for one Euro can suddenly increase or
                                                                                       1. Don’t blindly focus on interest rates.
                                                                                              Often, foreign exchange loans have lower interest rates than
                                                                                              loans in local currency. But remember that interest rates are
                                                                                                                                                                    A Foreign                   read this brochure to understand the risks of foreign exchange
                                                                                                                                                                                                loans. As an introduction you will find some basic terms and
                                                                                                                                                                                                definitions below and opposite.
                                                                                              just one side of the story. Increasing exchange rates may

   What is a Foreign
   Exchange (FX) Loan?
                                             What is an FX indexed
                                                                                              affect your monthly payments.

                                                                                       2. Be prepared for unpredictable exchange
                                                                                         rate changes.
                                                                                                                                                                    Currency                    Banks offer FX loans
                                                                                                                                                                                                You can take a loan from the bank in your local currency. But
                                                                                                                                                                                                banks also offer loans in foreign currencies (FX loans) or
                                                                                                                                                                                                loans that are tied to foreign currencies (FX indexed loans).
   A loan denominated in a
   foreign currency, such as
   Euro, Dollar or Swiss Franc.
                                             A loan denominated in Leu
                                             but tied to a foreign
                                             currency, such as Euro,
                                                                                              Do not count on the exchange rate to remain stable as it will
                                                                                              not! No one – not even banks – can predict future exchange
                                                                                                                                                                    (FX)Loan?                   Monthly payment: principal and interest
                                                                                                                                                                                                Your monthly payment consists of two elements: the principal
                                             Dollar or Swiss Franc.                                                                                                                             payment, being the repayment of the original sum of money
                                                                                       3. Borrow sensibly.                                                                                      that you borrowed, and the interest, or the costs of borrowing
   Repayment:                                Repayment:                                       Make sure you can afford your monthly payments to the                                             money, often calculated as a percentage of the amount
   Your monthly payments to
   the bank are in Euro. If you
   don’t have an income in
                                             Your monthly payments to
                                             the bank are in Leu. Howe-
                                             ver, when the exchange rate
                                                                                              bank, even if the local currency drops for example by 20% or
                                                                                              more. Use the calculator inside this brochure.                              Make sure you         borrowed.

                                                                                                                                                                                                Risks of FX loans
   Euro, you need to convert
   Leu into Euro each month.
                                             between the Leu and the
                                             foreign currency changes,
                                                                                       4. Foreign exchange income is not a guarantee.
                                                                                              An income in the same foreign currency as the foreign                       understand            Often, banks charge lower interest rates for FX loans. But,
                                                                                                                                                                                                these loans may not always be cheaper! For FX (indexed)
                                             your monthly payments in                         exchange loan reduces your risk. If exchange rate fluctuati-                                       loans, your monthly payments in local currency depend on
                                             Leu are also affected.                           ons cause an increase of your monthly payments, the same
                                                                                              fluctuations lead to increased foreign exchange incomes.
                                                                                                                                                                          the risks!            the exchange rate between your local currency and the foreign
                                                                                              But, a foreign exchange income (for example sent by family                                        The exchange rate between the local currency and the Euro,
                                                                                              members abroad) is often not a stable source of income.                                           Dollar or Swiss Franc is unpredictable.
                                                                                              Ask yourself whether you want to rely on these incomes for                                        Therefore, the monthly payments of an
                                                                                              repaying your loan.                                                                               FX (indexed) loan are also variable. If your
                                                                                                                                                                                                local currency devaluates, you need more
                                                                                       5. Don’t take a foreign exchange loan if you do not                                                      money to repay your monthly installments.
                                                                                          understand the risks.                                                                                 These increased monthly payments may
                             Let’s have a look at                                             In this brochure the exchange rate risk is explained. If you                                      even be higher than your monthly income.
                             the story of Dragos                                              do not understand this completely, please do not hesitate to
                             and Victor.                                                      ask for more information.                                                                         If you take a loan in your local currency,
                                                                                                                                                                                                your monthly payments are fixed. The
                                                                                                                                                                                                monthly payments of these loans do not
                                                                                                                                                                                                depend on the exchange rate.
                                                                                                                                      Sponsored by:
                                                                                                                                                                                                You will find more information inside this
                                                                                                                                                                                                brochure, with practical examples and a
                                                                                                                                                                                                tool to help you calculating your FX risks.
                         Note that in this brochure all examples are made under
                         the assumption of fixed interest rates.

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   Meet Dragos and Victor                                                                Exchange rates fluctuate                                                                                                  Calculator                      This calculator tool helps you to perform a quick check of the costs of an FX loan in different exchange
   Here are the twin-brothers                                                            Here you see how the exchange rate between the Leu and the                                                                                               rate scenarios, and compare the outcomes with the costs of a comparable loan in local currency. Insert
   Dragos and Victor. They both                                                          Euro can change.                                                                                                                                         your amounts on the dashed lines. Calculation is based on monthly flat rates, and fixed interest.
   work as plumbers in Bucharest.
   Last year, both Dragos and Victor                                                                                                       Romania - EUR                                                                                                                    Foreign currency loan                                   Local currency loan
   decided to buy new equipment.                                                                      4,3
   For each brother, the investment                                                                   4,2                                                                                                               Step 1: Your loan offers                   Dragos                                                                  Victor
   was 17,500 Leu. Both Dragos                                                                        4,1

   and Victor approached a bank to                                                                     4
                                                                                                                                                                                                                        A     Your loan amount in Leu                  175000 Leu                   ................   ................         175000 Leu

                                                                                            FX rate
   obtain a loan to pay for the equipment. The brothers could                                         3,9

   choose between a loan in Euro and a loan in Leu.                                                   3,8
                                                                                                                                                                                                                        B     Current exchange rate
                                                                                                                                                                                                                                                                     3.5 Leu / Euro
                                                                                                                                                                                                                              (Leu / foreign currency)
   Victor opted for the loan in Leu, with an annual interest rate
   of 18%. The first month, he paid 992 Leu to the bank. This                                                                                                                                                            C     Loan amount in foreign currency
                                                                                                             1   2   3   4     5   6   7   8   9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24
                                                                                                                                                                                                                                                              175000 / 3.5 = €5000
   included 729 Leu for the principal and 236 Leu as interest                                                                                                               months                                            (A / B)                                                               ................
   payment.Dragos was attracted by the lower interest rate of
   11% of the Euro loan. The first month, Dragos needed to                                When Dragos took the FX loan, he paid 3.52 Leu for one Euro.                                                                   D     Loan period in months                          24                     ................   ................               24
   convert 894 Leu to repay €254 to the Bank. This included                              Two years on, the exchange rate between the Euro and Leu
                                                                                                                                                                                                                                                                             11%                                                                      18%
   €208 for the principal and €46 as interest payment.                                   has changed. Now, he has to pay 4.22 Leu for one Euro. Victor                                                                  E     Annual Interest Rate
                                                                                                                                                                                                                                                                                                    ................   ................
                                                                                         took a loan in Leu and is not affected by this devaluation.
   Dragos’ average monthly payment was almost 100 Leu                                                                                                                                                                   Step 2: Your monthly payments
   cheaper than Victor’s.                                                                Let’s have a look at what this means for Dragos’ and Victor’s
                                                                                         monthly payments.                                                                                                              F     Monthly principal
                                                                                                                                                                                                                                                                   5000 / 24 = €208                                                                 729 Leu
                                                                                                                                                                                                                              (C / D)                                                              ................    ................
                                                                                         Monthly payments increase

                                                          263 Leu
                                                                                                                                                                                                                                                                    5000 x 11%
                                                                                                                                                                                                                                                                               = €23
                                                                                                                                                                                                                        G     Average monthly interest
                                                                                         Dragos took the FX loan, expecting to save 100 Leu each
                                                                                                                                                                                                                                                                                                   ................    ................             131 Leu
                                                                                         month, compared to his brother Victor, who took a Leu loan.                                                                          (E x C) / D                               24
                              208                         729 Leu                        However, as a result of the devaluation of the Leu compared
                                                                                                                                                                                                                        H     Monthly payment in                                     €232

                                                                                         to the Euro, Dragos’ monthly payments increased over time.
                                                                                                                                                                                                                              foreign currency (F + G)                                             ................    ................
                                                                                         One year after taking the loan, Dragos paid 984 Leu a month,
                                                                                         whereas his brother Victor only paid 871.
                                                                                                                                                                                                                        I     Monthly payment in Leu
                                                                                                                                                                                                                                                                 €232 x 3.5 = 813 Leu                                                               860 Leu
                        254 = 894 Leu                     992 Leu                                                                                                                                                             (H x B)                                                              ................     ................
                                                                                         Looking back, Victor made the wise choice by taking a loan in
                                                                                         local currency. In the end, the Leu loan was more than 2000
                                                                                                                                                                                                                        Step 3: The devaluation scenario
   Dragos: “I’m not afraid of                        Victor: “I want to know             Leu cheaper, even though the Euro loan looked cheaper at the
   taking risks.”                                    what to expect.”                    beginning.
                                                                                                                                                                                                                        J     Realistic Scenario: Leu devaluates
                                                                                                                                                                                                                                                                 813Leu x 1.1 = 894 Leu
                                                                                                                                                                                                                              by 10% (I x 1.1)                                                     ................     Compare your monthly payments
    Foreign exchange loan                            Loan in Leu                                                                                                                          total amount                                                                                                                  of a Leu loan and an FX loan in the
                                                                                                                                                                                         paid to the bank
    • Often lower interest rate                      • Often higher interest rate                                                                                                                                       K     Drastic Scenario: Leu devaluates                                                          two scenarios.
                                                                                                                                                                                                                                                               813Leu x 1.3 = 1057 Leu
                                                                                                                                                153 Leu        105 Leu
                                                                                                                             161 Leu                                           8 Leu
    • Monthly payments depend                        • Monthly payments not                                                                     877 Leu
                                                                                                                                                               879 Leu         888 Leu
                                                                                                                                                                                                                              by 30% (I x 1.3)                                                     ................
                                                                                                            Euro loan        733 Leu                                                       22831 Leu
      on exchange rate                                 affected by exchange rate
      fluctuations                                      fluctuations                                                                                                                                                      Step 4: Total costs
                                                                                                                         894 Leu               1030 Leu        984 Leu         895 Leu
    • Fluctuations are un-                           • Fixed monthly payments                                    month         1                  6              12             24
                                                                                                                             263 Leu
                                                                                                                                                                                                                        • The total costs of the loan if Leu     ½ x 24 x 813 =9756 Leu            ................
    • Loans may be more                                                                                                                                                                                                   devaluates 30% after 1 year
                                                                                                                                                208 Leu
                                                                                                                                                                                                                                                                  ½ x 24 x 1057 =12684 Leu
                                                                                                                                                               142 Leu
                                                                                                                                                                               11 Leu
      expensive in the long run                                                                             Leu loan         729 Leu            729 Leu        729 Leu         729 Leu     20781 Leu
                                                                                                                                                                                                                          (½ x D x I + ½ x D x K)

                                                                                                                         992 Leu                937 Leu        871 Leu         740 Leu                                  •	 Total cost Leu Loan
                                                                                                                                                                                                                                                                                   22440 Leu       ................
                                                                                                                                                                                                                           (D x I)                                                                                     ................    24 x 860 = 20640 Leu

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