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What negative interest rates might mean for your finances

In recent weeks, the government and the Bank of England have taken some unprecedented steps to support the economy through the coronavirus crisis. From the ‘furlough’ scheme, to the provision of billions of pounds of loans and grants, a range of emergency measures have been required to protect jobs and businesses.

While the Bank of England Base rate currently sits at its lowest level in history, the Governor, Andrew Bailey, has refused to rule out introducing negative interest rates as a further response to the pandemic.

But what are negative interest rates? What does it mean? And how does it affect your savings or mortgage?

What are negative interest rates?

One of the roles of the Bank of England is to act as a ‘bank for banks’. Financial institutions in the UK can deposit funds with the Bank of England, which traditionally pays interest on these deposits. The Base rate (or ‘bank rate’) is the rate of interest paid on these deposits and influences the cost of bank lending throughout the economy.

In March, the Bank of England cut the Base rate to a record low of 0.1%. Now, the Bank is seriously considering moving to negative interest rates, which would mean banks and building societies would be charged a small amount for keeping their money with the central bank.

Other countries, including Japan, Switzerland and Denmark are already operating with negative interest rates, while the European Central Bank’s (ECB) deposit rate is currently -0.5%.

Negative interest rates lower borrowing costs throughout the economy. They also force banks to lend, as otherwise, they have nowhere to keep their spare money without paying for it.

However, there are downsides to this policy. As well as costing banks money, they lower the so-called ‘net interest margin’ – the difference between the cost of borrowing and the cost of lending – through which lenders make money.

It’s also hard for banks to pass negative interest rates onto savers, and so their profit margins are squeezed.

So, how would a negative interest rates policy affect your savings and mortgage?

Savings rates could fall again, but will you have to pay a bank for holding your cash?

Thanks to the Base rate remaining low for a decade, savers have endured a difficult few years. Recent cuts to the Base rate have made things even worse.

Research by Moneyfacts found that in the three months since the coronavirus pandemic began impacting the UK economy, the average rate on an easy access account has halved, from 0.60% available on 11th March 2020 to 0.30% on 1st June.

A move to negative interest rates is likely to result in banks lowering deposit rates further if they can.

However, experts believe that it is unlikely lenders will start charging people interest on their savings.

Andrew Hagger, the founder of the financial information website Moneycomms, says: “Many would just withdraw cash and possibly keep it in the house, thus opening a can of worms around security and break-ins.

“However, if the Bank of England did introduce negative rates, I’m sure we would see even more savings accounts heading towards zero.”

If banks do decide to start charging clients for holding their savings, it is likely to be wealthy customers that end up paying fees. For example, in 2019 UBS started charging its high net worth clients a fee for cash savings of more than €500,000 (£449,000), starting at 0.6% a year and rising to 0.75% on larger deposits.

“It could be that super-rich clients in the UK get charged a similar fee as the commercial banks may wish to discourage large cash holdings which they are having to pay for,” says Hagger.

Mortgages

The majority of mortgages taken out in the UK in recent years have been on fixed rates. So, whatever happens to the Base rate, fixed-rate borrowers will continue to pay the same.

If you are on a rate that tracks the Base rate, or your lender’s Standard Variable rate, it is possible that you could see a reduction in your repayments if rates were to go negative. Many lenders have reduced borrowing rates in recent weeks as a result of the record low Base rate.

However, most mortgages have conditions in the small print that mean the rate charged will not fall below a certain ‘collar’.

For example, Skipton Building Society has a tracker at 1.29% above Base rate – but it can only go up. Santander specifies on some mortgages that the lowest rate it will ever charge is 0.0001%.

If rates were to become negative then, in theory, it would mean you would get paid to borrow money. If you took out a 25-year mortgage with a negative interest rate, then at the end of the 25 years, you’d repay less than you’d originally borrowed.

In Denmark, mortgages with negative interest rates went on sale last year. Borrowers with Jyske Bank were lent money at a rate of -0.5%, which meant the sum they owed fell each month by more than the sum they had repaid.

There seems to be no reason why UK lenders could not follow suit, although so far this seems unlikely.

Get in touch

If you have any queries about interest rates and how they could affect you, or you’re looking to improve on your cash savings return, please get in touch. Please email hello@sovereign-ifa.co.uk or call 01454 416 653 to find out how.

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