Foreign currency exchange for a Spanish property transaction
Assuming that you are starting off with Pounds Sterling (though the same applies to all other currencies like US Dollars or Swiss Francs), then the timing of your Euro purchase and who you buy them from can have a significant impact on the overall price you pay in Pounds Sterling.
Experience shows that many people both overpay for the Euros they need to buy their property, and take unnecessary risks with exchange rates once they have taken on a Euro exposure (obligation to pay Euros in the future).
Once you have bought a property in Spain, you may also need to make regular transfers to and from Spain, which involve foreign currency exchange. Even if the amounts are relatively small compared to the sums involved when buying and selling, they can still add up to a big number over time. Many people regularly overpay for foreign currency when making small transfers to and from Spain.
What are foreign currency exchange rates?
An exchange rate is the price of one currency unit in a different currency. In this respect exchange rates are no different to the price tags for ordinary products you find in shops and supermarkets.
Currencies are traded on the international foreign exchange market on a continuous basis and in staggeringly large volumes. In the very short-term currency exchange rates move in a random way in response to immediate levels of supply and demand. In the medium term exchange rates reflect the differentials in interest rates between currencies, and in the long term they reflect the differentials in inflation rates between economies. However, all you really need to understand is that currencies are sold by various types of currency dealers such as banks or currency brokers, that exchange rates are constantly changing (they change every 2 seconds) and that in the short term it is impossible to predict with any certainty which way they are going to move.
What impact can exchange rates have on the price of my Spanish property?
When you buy a property in Spain you take on a Euro exposure – an obligation to pay someone a certain amount of Euros at a specified date in the future. Unless you already have Euros (for example because you are paid in Euros and have all your savings in Euros) you will have to buy Euros using Pounds Sterling or another currency. Therefore it is the total price of your Spanish property purchase in Pounds Sterling that matters to you most.
But because exchange rates are constantly changing, the value of your Euro exposure in Pounds sterling is constantly changing as well. The fluctuations in the Pound Sterling / Euro exchange rate can have a big impact on the price in Pounds that you end up paying. The following example using Pound Sterling / Euro (GBP/EUR) demonstrate how big an impact exchange rate fluctuations can have on your Spanish property purchase.
First, let’s see how the GBP-EUR exchange rate changed over a five year period, as illustrated by this chart.
The exchange rate went from around 1.15 Euros to the Pound in January 2011, to around 1.35 €/£ five years later, an appreciation of 20% in the Pound’s favour. Currencies are in constant fluctuation, which means the price you end up paying could change every day if you take no steps to protect yourself.
Of course most people don’t buy property over a five year period. A typical conveyancing process might take around 3 months. So let’s see how the GBPEUR exchange rate changed over three months to the end of December 2015.
The exchange rate went from around 1.35 €/£ at the start of October 2015, to 1.43 €/£ in mid-November, and back down to 1.35 €/£ at the end of December, a maximum change of 6% during the period. On a purchase of €200,000 that translates into a €12,000 difference depending on the date of purchase. So exchange rate movements can have a big impact on the price you pay if your funds are in another currency.
This becomes an important issue if you sign a contract to complete a purchase within a period of months. Because exchange rates are constantly changing, you don’t know how much you Euros will cost you when the time comes to complete before notary. This is particularly true when buying off-plan or under construction, when completion might be six months or more in the future.
Typically when people buy a resale property in Spain they pay a deposit of around 10% at the time of signing a private sale contract with the vendor (often buying Euros from their bank at extortionate rates), and agree to pay the remaining 90% at the time of signing of the deeds before Notary. In most cases the deeds are signed between 1 and 4 months after signing the private sale contract. This means the buyer will carry a Euro liability for a couple of months, and fluctuations in the exchange rate over even such a relatively short period can have a significant impact on the price in other currencies that the buyer has to pay.
Exchange rates introduce a significant element of uncertainty (called exchange rate risk) for foreigners buying property in Spain. The next section explains how you can reduce or eliminate foreign exchange rate risk.
How can I manage my foreign exchange rate risk?
When you sign a contract to buy a property in Spain and take on a Euro liability you become contractually bound to deliver a certain amount of Euros at a specified date (or dates) in the future. If your funds are in another currency like Sterling it then becomes important to manage your exchange rate risk.
At the time of taking on the Euro liability – probably when you sign the private sales contract – you know how much the liability is worth in Pounds because the exchange rate of the day is known. However you cannot be sure of the value in Pounds of this Euro liability in the future. Depending upon how the exchange rate moves your property might cost you more Pounds or less than you have budgeted for. Of course you would be happy if a strengthening Pound were to decrease the value of your debt in Pounds, but you might be devastated if a weakening Pound were to increase the cost and leave you significantly out of pocket. For this reason British buyers of Spanish property general prefer the security of knowing exactly how much they will have to pay in Pounds over the chance that they will end up paying less. Fortunately there are several financial instruments that you can easily purchase to help you manage your exchange rate risk.
Forward contracts allow you to fix the exchange rate that you will pay in the future, be it on one date or on several different dates in the case of stage payments spread over many months. With a forward contract you know exactly how much your property purchase will cost you in Pounds regardless of the what happens to exchange rates. Obviously in a forward contract the currency dealer who sells it to you takes on the risk and therefore has to price this into the exchange rate you are offered. Nevertheless you benefit from the security of knowing how much your property will cost you and the peace of mind that this gives you. Furthermore a good currency broker will be able to offer you a forward contract at a reasonable price.
Although forward contracts are the most common way of managing exchange rate risk there are financial instruments even more exotic than forward contracts. For instance market orders that limit the downside of your exchange rate risk whilst leaving the upside open. This means that if the Pound strengthens against the Euro you will benefit from this but at the same time you are protected against the Pound weakening beyond a certain rate. So you know from the very outset how much your property will cost you in Pounds in the worst case, and can budget for this, whilst leaving the door open for a pleasant surprise if the Pound strengthens in your favour.
These types of financial instruments (and there are others too) might sound too complicated for you. However, they are actually quite simple, can be extremely useful, and a good broker will be able to advise you on the most suitable instrument given your circumstances and requirements.
Save money on foreign currency exchange (Forex) for Spanish property
Specialist currency dealers and banks are the main suppliers of foreign currencies to foreign buyers. Both dealers and banks buy their Euros from the international currency market, add on their commission, and then sell the Euros on to you.
Most people buy their foreign currency from their bank. However, high street banks are likely to give you the worst exchange rates on the planet. So why do people still buy their Euros from banks? Partly out of habit – after all they have probably bought their holiday currencies from their bank in the past – but mainly due to a lack of insight into foreign currencies and who to turn to for the best rates. That said, banks are getting more competitive than they used to be.
The best place to buy Euros is a specialist foreign currency dealer. They tend to offer the best rates, lowest commissions, and specialist advice on how to manage exchange rate risks.
For Euros, British buyers of Spanish property may be better off dealing with specialist currency brokers, who tend to offer better exchange rates and more service than most high street banks.
HOWEVER, using a currency broker is not without risks, the most serious being the broker going bust whilst in possession of your money. So, before using a broker make sure they have professional indemnity insurance and use client accounts to protect you money. Also, make sure they are authorised and regulated by the FSA if you are based in the UK.