The continuing impact of the covid-19 pandemic is exerting a strong influence in areas other than that of personal health. The UK economy has been hit hard by the recent lockdown, and the situation for the near future is uncertain. The property market stalled as lenders began withdrawing their mortgages – something that has reversed recently – and viewings become impossible thanks to the social distancing measures.
The talk now is that the Bank of England is considering a negative interest rate as the baseline. In truth, it has little else in the way of options. The rate is at an all-time low as we stand – 0.1% – and any lower would mean zero or lower. What happens with a negative interest rate, why is it perhaps necessary, and how will it affect the property market? We’ll start by explaining negative interest in simple terms.
What is Negative Interest?
When you save money in a bank you are paid interest on the amount in your account. This is influenced by the base interest rate set by the Bank of England. It follows, then, that with a negative interest rate, you will pay the bank for keeping your money in the account! As this is not a situation any of us want to be in, the negative interest rate should therefore encourage us to spend our money rather than save it.
That won’t always be the case, but where a lot of money is held in an account it would make sense to withdraw it and perhaps invest elsewhere. It may also inspire people to keep their money in physical cash in the home, which is inadvisable as it presents a security risk. The net result of a negative interest rate is that, over time, any amount held in a bank account will slowly reduce. With larger deposits this may be more noticeable than with a simple savings account.
It’s interesting to note that some countries are already working with a negative interest rate. These include Japan, Denmark, Sweden, Switzerland, and those countries that are within the Eurozone. It remains to be seen if the UK will follow, but the Bank of England is considering it seriously given the dire nature of the economy.
Surely, then, this means that people with mortgages will start being paid to hold them? It may seem that way, but it’s not likely to happen.
How Will Negative Interest Affect Mortgages?
The Bank of England base interest rate may be a major influence on lending and borrowing, but should it fall below zero that does not mean mortgages will also do so. Let’s assume, however, that you do end up with a negative interest mortgage – here’s what would happen. With a negative interest mortgage you would not receive a physical monthly payment.
What the bank or lender would do is reduce the outstanding loan each month. The problem with this is that it discourages the borrower from paying back any more of the debt, as there is no incentive to do so. Effectively, the bank would pay you to borrow money from them. This has in fact happened in some European countries – in Denmark one bank offered a -0.5% interest rate on a 10-year mortgage – and it becomes known as ‘reverse charging’, but it is not likely to happen in the UK.
During the financial crisis of little more than 10 years ago, the Bank of England rate fell from 5% to 0.5% in a year. This led to many people who had tracker mortgages paying far less. A tracker mortgage is one that follows the Bank of England rate. It’s a gamble in many ways as it could rise or fall, depending upon many economic factors that influence the markets.
After that dramatic reduction in the base rate the banks and lenders amended the terms of tracker mortgages. They now have a fixed minimum positive interest rate so cannot drop below zero, irrespective of what happened with the Bank of England rate. A further factor is that most mortgages in the UK are fixed rates, so will not be affected by a change in the base rate.
One advantage may be the availability of cheaper mortgages, which is something that is worth keeping a check on should you be looking to re-mortgage anytime soon. What effect will a negative rate have on the property market itself?
Will Negative Interest Harm or Benefit the Property Market?
In theory, a negative interest rate should encourage people to move their money away from banks. One area of potential investment for those with sizeable assets could be in property. This could mean a rise in property purchases. Furthermore, lower interest rates make it more affordable for borrowers. Mortgages should – again in theory – become more affordable, and therefore more attractive to people looking to move to a new house or buy for the first time.
However, there is a knock-on effect that is not a positive, and that is a potential rise in house prices. That’s great for those selling, but not so for the buyer. This happens because cheaper mortgages will lead to greater demand for homes, which will drive up prices in a market that is already facing an excess in demand.
There are further factors to consider: it’s worth bearing in mind the reason for considering a negative interest rate, which is the overall effect of the covid-19 pandemic. This has led to job losses and reduced income in many households, and an uncertain future in which unemployment will surely rise means less consumer confidence and lowered inspiration to buy.
Negative interest rates are generally a boost to the property market in terms of lower mortgage rates and higher prices, but don’t expect your tracker mortgage to start paying you money! If moving home is on the cards this may be the time to start looking for a mortgage, assuming the Bank of England does opt to introduce a negative rate. Notably, it would be the first time such has occurred in the UK.