Back in March, interest rates fell to the lowest level in the Bank of England’s 326-year history. Now, the governor, Andrew Bailey, has indicated that the central bank are considering introducing ‘negative interest rates’ for the very first time in the UK.
Bailey said the Bank was keeping the outlook for how low UK rates could go – and other monetary policy tools available – under “active review”, adding: “We do not rule things out as a matter of principle. That would be a foolish thing to do. But that doesn’t mean we rule things in either.”
Designed to support the economy through the deep recession caused by the coronavirus crisis, this would certainly be an unprecedented step. But what are negative interest rates? And how do they work?
Read on for more and the answer to the question: what would negative interest rates mean for my mortgage.
What are negative interest rates and how do they work?
Interest rates are one of the main tools the Bank of England uses to maintain balance in the economy. Changing the central Base rate guides how individual banks and building societies determine their own lending rates.
- The Bank raises interest rates to help cushion the economy against inflation. This is because higher rates make borrowing by consumers and businesses more expensive
- The Bank lowers interest rates when the country is facing a recession because it encourages borrowing and spending, which stimulate the economy
Normally, the Bank of England pays interest to high street banks and lenders for holding their money. Moving to negative interest rates would mean that the Bank would charge high street banks and lenders for depositing their money centrally.
As banks would be paying to hold deposits the idea is to get them to lend more money out instead, encouraging the economy to grow. Interest rates on savings would also fall and therefore people and businesses would be encouraged to either spend or invest it.
Theoretically, negative interest rates would make it less attractive to keep money in the bank as you’d be charged for depositing your savings. At the same time, negative rates would make the cost of borrowing very cheap, encouraging more people to borrow money to spend.
While the UK has never previously taken this step, other countries around the world, including Japan, Switzerland and Denmark have adopted a negative interest rates policy. The European Central Bank’s current rate is -0.5%.
What would negative interest rates mean for my mortgage?
Over the last few years, most of the mortgages taken out in the UK have been on a fixed rate. So, if your mortgage is on a fixed rate, then you won’t see your repayments change – irrespective of what happens to underlying interest rates.
If you have a tracker rate mortgage, or your home loan is linked to your lender’s Standard Variable Rate (SVR) then you could see a reduction in your repayments if interest rates were to fall again.
However, it’s worth bearing in mind that most mortgage lenders have a ‘collar’ below which the interest rate charged will not fall.
For example, Nationwide say that they will never reduce the rate deals track below 0%. So, if you are on a deal at Base rate plus 1%, your interest rate will never fall below 1%.
In Europe, lenders in countries with negative interest rates have offered some unprecedented deals in the last year:
- Denmark’s Jyske Bank offered a 10-year deal with an interest rate of -0.5%. At the end of the term, borrowers owed less than the repayments they had made (although the Danish mortgage system does involve fees which mean the deal was not quite as remarkable as it first appears)
- Finland’s Nordea Bank offered a 20-year deal with an interest rate of 0%.
Experts don’t believe that we will see negative interest rates in the UK. However, the cost of new mortgages is already extremely cheap and, even though rates may not fall below zero, they are at exceptionally low levels.
Financial analysts Moneyfacts reported in mid-May that the average rate on two- and five-year fixed deals fell to the lowest level since their records began in July 2007. Last month, the current average two-year fixed mortgage rate was just 2.09%, while the average rate for a five-year fixed mortgage was 2.35%.
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