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Please DON’T gamble on currency risk with borrowed money

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currency2Many factors affect the exchange rates and interest rates of currencies, such as political events, financial forecasts, economic stability, and inflation management. But the underlying theory remains the same. Countries that need to attract deposits generally do so with higher interest rates than countries that are doing better economically. Countries that are doing fine tend to have stronger currencies.

When It Makes Sense

Borrowing in a foreign currency makes sense only in a few circumstances. One such instance is when you don’t require the maximum debt allowed by the bank; when the bank allows you to borrow 80 percent of the property’s cost, but you borrow only 50 percent. That allows breathing room for currency and interest fluctuations.

Another instance is when you plan on repaying the borrowed amount using the same currency; using your Singapore dollar salary, for example. Also, borrowing a much smaller amount than a home mortgage is a safer circumstance.

The first golden rule when playing this game is not to borrow the maximum and to always match the borrowing currency with your planned repayment currency, if possible. The second golden rule is not to gamble on currency risk with borrowed money unless you can afford to lose it.

Borrower Beware

Financial advisers will show you past records and statistics to demonstrate that the fallout from this risk rarely happens. They will tell you that since you can get interest on the callable amount, you are adequately protected because it is money that you still own. They will tell you that when you see currencies moving in the wrong direction, you can switch back to the other currency.

I will tell you that they are usually misleading you. Often, they will not even be familiar with the basic theory of interest rates because they are blinded by the prospect of high commissions at the expense of ignoring the risks.

Many financial advisers won’t tell you that every time you switch currencies, they will make a significant profit on the bid or offer-spread of the currencies.

They won’t tell you the statistics that show how many people have been financially crippled by taking currency risks with which they are not familiar. They won’t tell you that you should never gamble on currencies with borrowed money, because you risk having the bank take your house away.

But I will tell you. As you can see, I take my job as their archenemy very seriously.