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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
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.
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
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
€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
5000 x 11%
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
• The total costs of the loan if Leu ½ x 24 x 813 =9756 Leu ................
• Loans may be more devaluates 30% after 1 year
½ x 24 x 1057 =12684 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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