If you use your bank to change currencies or send money abroad, theres a good chance that youre getting ripped-off on the exchange rate. Financial institutions often stick a large margin on foreign exchange (forex) rates when dealing with retail clients, figuring that its a way to make extra profits without most clients realising what’s going on.

The size of the mark-up varies, but with some banks it can be a premium of 4% or more sometimes including a fixed fee on top. Given that the bid/ask spread in the interbank currency market (where big institutions trade) is almost non-existent for major currencies, these kinds of margins are clearly excessive.

The good news is that there is often a way to cut them significantly. Instead of using your bank to change currencies, you can use a currency broker (sometimes known as a foreign exchange transfer specialist) or a peer-to-peer currency transfer website. These firms offer far more competitive exchange rates and can often bring the cost down to 1% or less.

Currency brokers and P2P websites

Currency brokers such as TorFX and HiFX have been growing in popularity in recent years as people become more aware of how much their banks have been overcharging them. These firms work by buying the currency you want in the institutional market and selling it onto you for a commission.

Peer-to-peer (P2P) platforms such as TransferWise and CurrencyFair are a newer development and operate in a different way to the brokers.When you sign up to one, you join a large pool of other individual users who all want to carry out their own currency transfers. The P2P platforms work by matching all those users on opposite sides of the transaction (for example, those that want to sell sterling for dollars with those that want to sell dollars for sterling) and take a commission for doing so.

Which of these approaches is best depends what currencies you want to convert and how much money is involved. In general, the P2P platforms offer very good rates for smaller transactions, but its likely you could negotiate better rates for big deals directly with a broker.

How much could you save?

How much margin you save depends on how much you’re transferring – larger amounts will usually save you more. Different money transfer firms use different fee structures and the cheapest for one transaction may not be the cheapest for another. So it’s important to shop around and compare rates.

Below, I’ve compared the costs of a bank, two currency brokers and two peer-to-peer transfer websites for varying sizes of transfer from sterling to Singapore dollar. The rates are tradeable online quotes, taken around 7pm on Friday 13 February 2015. The interbank rate at the time was around S$2.086 per pound.

The firms compared and their charges were:

1. A bank, HSBC UK. They quoted a fee of £4 (£0 to transfer to another HSBC account), plus a variable exchange rate depending on transfer size.
2. A currency broker, HiFX. They quoted a fee of £9 for the two smallest transfers and nothing for larger ones, plus a variable exchange rate depending on transfer size.
3. Another currency broker, WorldFirst. They quoted a variable exchange rate depending on transfer size.
4. A peer-to-peer website, TransferWise. They quoted a commission of 0.5% and set the exchange rate at which users money is exchanged at the interbank rate.
5. A second peer-to-peer website, CurrencyFair. They quoted a flat fee of £3, plus a commission of 0.15% based on the rate at which users money is exchanged. Unlike TransferWise, this is not the interbank rate but is set by supply and demand on the platform (so you could get a better or worse rate). If no exchange rate is available for the currency you want (because not enough users are offering it) CurrencyFair offers you the interbank rate plus a commission of 0.4-0.5% – in my comparison, this seems to have been what happened.

I put all these numbers together to calculate the effective interest rate (including flat fees) and the resulting margin over the interbank rate that you’d pay through each of these firms on six transactions from £1,000 to £50,000. The results are in the table below.