Negative interest rates – how would they affect you?

Many of you will recall the 1980s when double digit interest rates were the norm. Mortgage interest, at its peak was, in hindsight, a staggeringly high 16% per annum. The concept of negative interest rates at that time was not even considered. Surely it could never happen.

Thirty years on, the base rate has been cut to a record low of 0.1% to help support the economy amid concerns about the coronavirus pandemic and the unthinkable may happen as the Bank of England has not ruled out cutting interest rates to below zero in an attempt to further boost the economy. This comes after official figures showed that inflation had fallen to a four-year low of 0.8% in April – well below the Bank’s 2% target.

Japan’s Central Bank, the European Central Bank and some Nordic countries have already adopted negative interest rates and no doubt, the Bank of England is monitoring the effect of this closely.

The rationale
If a country's central bank sets its base rate below zero, high street banks must effectively pay to deposit cash with it. In theory, this will encourage high street banks to offer cheaper loan rates to households and businesses to encourage borrowing. This allows banks to make up the deficit of paying to deposit cash by increasing lending. In turn, consumers and businesses have more money to spend, thus stimulating the economy.

How could negative interest rates affect savings?
For savers, with interest rates at an almost negligible level already, negative interest rates provide even more bad news as they would see their cash eroded as banks charge to look after their cash. 

Is it a move that the big banks would consider?
Potentially, there would always be competition that would still pay interest on savings and look to lure savers and the bigger institutions could face the loss of millions of pounds of deposits.

How could negative interest rates affect mortgages?
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 the borrower paying back less than they had been loaned.

For example, if a borrower had a 25-year mortgage and paid negative interest rates throughout, at the end of the term the total repaid would have been less than the original amount borrowed. This is an unlikely scenario as no bank would offer long term negative rates. It would be commercial suicide. Mortgages will always have a margin over base rate and fees will also provide the lender with an additional degree of income.

The more likely scenario is that standard variable rates and fixed rates may drop further.

And what about ‘Tracker’ mortgages? These track the base rate and so the interest rate varies as base rates move. However, ‘Tracker’ mortgages would normally also stipulate a minimum rate which stops it going below 0%.

In summary then, negative interest rates, if they ever happen in the UK, not surprisingly, mean bad news for savers and good news for borrowers.