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A question came up in my facebook group recently about what might happen if interest rates became negative in our country.
It’s a GREAT QUESTION!
So here goes….
What Are Interest Rates?
Did you know that your personal bank has it’s own bank? The central bank – The Bank of England controls how much interest they give to your bank on the money they have stored there (your money).
Interest rates can be changed to keep the economy stable.
When bad things happen, people tend to get a bit jittery about spending money on big things like houses etc. There is also the hope that if prices are falling, waiting would mean getting a better deal on a house.
But the problem with this thinking is that the lower prices get, the more hardship companies will experience due to lower profits. This leads to low wages and redundancies, further depressing the economy because no one has any money to spend!!
So interest rate changes are used to correct these types of scenarios.
When the interest rates go up, your bank has a higher incentive to have lots of money stored. They are likely to pass these rates onto you – when this happens, you’ll find lots of new savings accounts offering all sorts of deals.
When interest rates go down, your bank is being pushed away from storing money, and is being encouraged to lend it out to make more money than storing it. This is when it’s a good time for lenders (mortgages/loans etc), because rates will be cheaper.
This is a very simplistic explanation, but I’m not into making things complicated (mainly for myself tbh).
What About Negative Rates?
Ok, so negative rates means that your bank now has to PAY to store money at The Bank of England. So, as you’ll guess, they don’t like this very much, so will find other places to put the money – likely by lending more of it out to us.
However, if it were to happen, it is likely they would be super-picky of who they loaned money to. It wouldn’t be people who had poor credit ratings, because they don’t want to run into a situation where people couldn’t pay back the loans when interest rates rose again (particularly mortgages).
So How Might This Affect Me?
Because this touches so many areas, I looked around for good resources online to help. I found a great one from The Money Dashboard which does what I like to do – break things down into easily digestable pieces!
Mortgages
This could be good or bad depending on your point of view.
This quote from moneywise.co.uk sums up the GOOD really well:
“In theory, negative interest rates are good news for mortgage borrowers as they will likely result in lower rates.
With negative interest rates the bank effectively pays the customer to borrow money, so it would mean paying back less than you have been loaned.
For example, if you have a 25-year mortgage and paid negative interest rates, at the end of the term you will have repaid less than the original amount you borrowed”
That’s great if you’re just about to take on a mortgage, or already have one in place on a variable rate, so what is the bad in all this?
With banks lending out cheap mortgages, this means in theory more people would be able to buy a house. BUT – with more demand, there is a consequence, and that is HIGHER house prices. So if you are no where near buying a home yet, it could leave further away from being able to afford one.
Savings
Negative rates are not good news for savers. You may end up in a situation where you are PAYING the bank to save your money for you. You’d be forgiven for thinking that saving was a pointless waste of time.
Could this lead to the rise of people stuffing cash into their mattress or being tempted to invest their money and take on unnecessary risks? Don’t get me wrong, I love investing, but investing without knowledge and guessing what to do is taking on unnecessary risk.
And in the confusion and panic, perhaps savers might even fall into the arms of scammers? Remember – if it looks too good to be true, it probably is.
Debt
A negative rate world could be great news for people who want to consolidate debt or take on a cheap loan. But banks are aware that this would ultimately end up in a loss for them, so they will likely restrict these to those with excellent credit scores.
Besides – if we save less because interest rates are so poor, this means your bank has less to lend out, and this will have a knock on effect by restricting how many loans they can give.
“Low interest rates over the past decade have incentivised borrowing and discouraged saving. One reason our economy has unravelled with such speed is that too many households and firms have gone into this crisis in a highly vulnerable state, with heavy debts and no buffer of savings.” – thisismoney.co.uk, Ruth Sunderland
Bonds
When you buy a bond, you’re lending money to the government or a company on the promise that it will be paid back in a fixed time period in full with some extra on top as a thank you.
However, in times of negative interest rate, there is no extra money around to pay people more than what they lend, so they would mean getting back the amount you provided, or less! Unfortunately, this has started to happen in the UK. This means that there is more incentive for the government to borrow money than to save it because they are getting paid to borrow!
Why would someone buy a bond with a negative interest rate? Because they are hoping that if things pick up again during the time they are holding the bond, they will be able to sell it and make some profit.
Final Thoughts
So there you have it – 4 ways in which negative interest rates may impact you if it happens. Don’t think that it won’t, because several countries around the world have needed to do this in order to get us all out there and spending again. I just hope that if it does, it won’t be like it for long. Try not to base your decisions around what the banks are doing – focus on building your own personal economy, so that when things like this do happen, it doesn’t impact you to any great extent.
Let’s watch this space shall we?
Until next time,
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