What do negative interest rates mean for me?

Hello everyone! There’s been some commentary in the UK Financial Press about the possibility of the UK introducing a negative interest rate in line with some other European countries to try and boost the economy.

What is significantly less clear to most people is what this actually means in practice and for your money, so today I thought I’d write an explainer on interest rates and what this means.

What do interest rates do?

So fundamentally the central interest rate determines the cost of funding from the Bank of England to other banks, which subsequently drives the cost of borrowing to you, me and businesses through loans and mortgages. It also affects the rate of savings via deposits and savings account.

The Bank of England remit covers two core things for this purpose – the overall health of the economy and controlling inflation. Inflation is where prices start to go up and the effective spending power of money today begins to drop.

The interest rate is a good tool to achieve these aims as it help manage the speed and flow of money around the economy. If inflation is beginning to rise, the bank will tend put up interest rates to try and encourage consumers and business to borrow and spend less, thus limiting the ability of prices to keep rising. If the economy needs a shot in the arm, interest rates get lowers to do the opposite and encourage spending/borrowing.

Well, that’s been the basis of modern central banking up until now – but the problem is that we’re still seeing a weak economy with interest rates right at absolutely rock bottom.

So there’s a question of where do we go from here, and some economists have argued that a negative interest rate is the next logical step.

Coins dropping onto the table

What does a negative interest rate mean?

It therefore creates a strange scenario where instead of the banks paying to borrow from the central bank, they will be paid to do so – and if you want to stash cash with the central bank you’ll have to pay to do so.

This is essentially an ultimate “turn the economic taps” on environment where banks are actively incentivised to lend and consumers to spend. Sitting on money actively penalises you.

Would negative interest rates mean I have to pay to keep money in my bank account?

It’s relatively unlikely. Whilst economically you’re not encouraged to to save money other countries where negative rates have happened banks have not wanted to take the reputation hit of charging people to use an account and sucked up the costs.

The banks need to make money somehow, so it wouldn’t be altogether surprising to see other costs and charges beginning to creep in – albeit that’s speculation from my part.

The pain for savers comes from the fact that the already terrible rates of interest you’re getting for saving at the moment are likely to switch instead to being absolutely nothing…

It’s not out of the question that if rates were to move more severely than 0.25% negative, charges for maintaining a current account might creep in.

UPDATE: Well, the day after I write this HSBC has publically commented that they’re considering introducing charges for current accounts given the thin profit margins and the threat of negative rates.

I read this as a testing of the waters to see how people react – I know bank customers are loyal and do tend to stick accounts, but I think it’ll be so unpopular I can’t see them actually pulling the trigger unless really forced to – but watch this space!

What would Negative Interest Rates mean for my mortgage?

Well there are a few scenarios here.

Firstly for anyone wondering in excitement if it means they may not have to pay their mortgage, I’m afraid not…… a mortgage has a risk premium above the central bank interest rate – but it’s a nice thought!

A picture of a house

If you’re on a variable mortgage you’d be in the best scenario here – rates moving downwards is generally a good thing for you and so you’d feel the benefit of your interest being reduced immediately.

If you’re on a fixed rate mortgage you’ll see no effect until the end of your term – if rates are still reduced at the end of it you may be able to remortgage at a lower interest rate and pay less.

WHAT WOULD NEGATIVE INTEREST RATES MEAN FOR MY CREDIT CARD?

This is a little more unclear, but you’d expect the cost of any credit to drop slightly.

The card providers themselves usually do pass on the lower rate fairly immediately as quite often the APR (rate of interest) is based on the base rate plus the card providers interest.

That’s not the case everywhere though, and sometimes passing on rate saving will be at the card issuers discretion.

We at the Wilderness always advocate paying off your card in full if you possible can in any case – you can read why at this point on not paying off the minimum on your credit card.

And that’s it!

If you have any other questions about the effects of negative interest rates on your finances please let us know and we’ll get them added in!

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