By Moshe Wilshinsky
Given the recent climb of the value of the U.S. dollar against the New Israeli Shekel (i.e. the rise of the exchange rate) and the growing expectation that this is not a temporary situation, I want to point out how this can affect the cost of your mortgage.
Currency risk and exchange rates are not something commonly dealt with in residential mortgages in North America. The closest event would be the introduction of LIBOR in the 1980s as an Adjustable Rate Index. This was the first time that a non-US centric index was introduced into the U.S. mortgage markets. In Israel, however, foreign currency indexed loans are not uncommon.
I would like to discuss the foreign aspect of foreign currency — not in terms of the economy but in terms of the borrower. Allow me to illustrate my point by contrasting two different borrowers:
Borrower “A” is a mortgage borrower who works in the U.S. and has all of his income in U.S. dollars. In addition, all of his savings and most of his investments are in U.S. dollars.
Borrower “B” is a mortgage borrower who works in Israel and whose entire income is in New Israeli Shekels. All of his savings and investments are in New Israeli Shekels as well.
Let’s say that the amount borrowed is NIS 360,000 linked to the U.S. dollar at an exchange rate of NIS 3.60 = $1.00. If, over time, the exchange rate goes up to NIS 4.00 = $1.00, the difference in the exchange rate will change both the amount of the monthly payment as well as the remaining principle balance. How a borrower is affected by these changes depends on his situation.
For Borrower “A,” the changes in the monthly payment and remaining balance in NIS terms are academic since the U.S. dollar value has stayed the same and the US Dollar value is what concerns Borrower A when making a monthly mortgage payment or when considering paying down principle.
For Borrower “B,” his payments have increased as well as the amount of money owed on the remaining principle balance. Since borrower B has no other serious connection to the US Dollar other than his Mortgage and he is using the NIS he earns to pay his US Dollar link mortgage, which just became more expensive even though the interest rate may still be low. This is called “currency risk” and it is an actual increase in the cost of the loan and when calculated as an interest rate could be higher than the interest rate listed on his mortgage statement.
Governments and businesses deal with fluctuations in currency exchange in different ways to ensure they can absorb and or deal with the additional costs foreign currency exchange rate fluctuations can cause. While every consumer will eventually be directly or indirectly affected by these very same foreign currency exchange rate fluctuations, they should not be introduced into the cost of paying a mortgage unless it make sense in the context of the borrower’s overall financial situation as explained above.
The linkage to the dollar that once made sense may not make sense now, if circumstances have changed from when you originally took out your U.S. dollar linked mortgage, for example if you had a dollar income when you originally borrowed the money and now you don’t — the trend in the NIS to U.S. dollar currency exchange rate fluctuations that once may have been academic should now be a concern since you will need to pay additional shekels which will in effect increase the interest on your mortgage. If this is the case foreign currency exchange rate fluctuations are of interest to you whether you know it or not.