Thursday 5 September 2019

How low can interest rates go?

We may have gotten used to a new normal with an era of low interest rates, but the consensus that “rates can’t go any lower” has been blown apart by a Danish Bank who is offering the world’s first negative interest rate mortgage. This effectively means the bank is paying borrowers to take money off their hands!

And this isn’t some tiny bank trying to attract business through a sensational headline; this is Denmark’s third largest bank. They are offering 10-year mortgages at minus 0.5%; meaning borrowers make their monthly repayment as normal, but their mortgage balance will decrease even more than the amount they have paid. Another Danish bank has said they will begin to offer 20-year deals at 0% and even a 30-year mortgage at just 0.5%!

This has come about due to the rates on offer in the money markets, whereby the banks can borrow money at a negative rate and are thus passing this on to customers. It seems big institutional investors are happy to accept a small loss for the perceived security of lending money to a bank, rather than risking a larger loss by investing elsewhere.

It's also the reason that banks aren’t offering much interest on your savings - it costs them money to look after it and they make nothing from it! That has led to some banks gesticulating that they will have to charge savers to hold their money, rather than paying any interest at all. At the moment only the Swiss Bank UBS has taken this approach, charging wealthier clients 0.6% a year if they deposit more than €500,000.

Whilst no one seems to be predicting negative interest rates on UK mortgages yet, the banks are continuing to cut their mortgage rates. Five-year fixed-rates at 90% loan to value are available at 2.25%, whilst at 75% loan to value the interest rate drops to just 1.68%. Interestingly the cheapest buy-to-let mortgage at 75% loan to value comes with an interest rate of 2.17%; cheap by most standards, but still nearly a third more expensive than the equivalent owner-occupier mortgage.

Super low interest rates like these will add fuel to rising house prices. In fact, since the 1980’s the amount of interest payable on the average mortgage stayed largely the same, until the current decade when interest rates dived through the floor. This, however, doesn’t factor in the cost of repaying the loan amount, which is why many mortgage companies are extending both the age of people they’ll lend to, as well as the length of time the mortgage will last, helping to soften the monthly outgoing.

Whether we ever get to a stage of banks paying us to take out a mortgage is still unclear. But I do believe ultra-low mortgage rates are here to stay along with longer-term mortgages. If mortgage rates do rise it would spell the end of a 40-year pattern and would most likely lead to house prices reversing their historical trend too. 

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