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Everything you (and your wallet) need to know about negative interest rates

Everything you (and your wallet) need to know about negative interest rates

There’s been a lot of chatter about the Reserve Bank of Australia (RBA) potentially cutting the cash rate soon, but with only 25 basis points separating it from zero per cent, could we see negative cash rates in Australia?

Homeowners and deposit-holders affected by variable interest rates might be wondering what a negative cash rate environment would even look like, and if it’s even possible. Here is everything you need to know about what may happen if the Reserve Bank of Australia were to cut the cash rate below zero per cent.

How do interest rates fluctuate?

Variable interest rates, such as your variable home loan rate, savings account rate and term deposit rate, are set by your provider and influenced by the RBA’s cash rate. The RBA meets on the first Tuesday of each month (except for January) to set this rate. They will make the decision to raise, lower or hold the cash rate as early as next Tuesday.

  • Put simply, if the RBA were to cut rates into negatives this may be good news for mortgage holders, and bad news for savers.

Home loan lenders are encouraged to follow the cash rate movements to pass savings on to their borrowers, in an effort to lower their home loan repayments and often encourage more spending in the economy. Also, one of the key benefits of a negative cash rate is, in theory, that businesses will be encouraged to borrow more money and invest it back into the economy.

Meanwhile, those with savings accounts may see their already miniscule interest rates fall further, and term-deposit-holders coming to the end of fixed periods will be entering an environment of record-low returns. Providers may even be put in the position of charging deposit-holders to keep their money with them.

While negative cash rates could mean more investment in the economy, it may also mean everyday Aussies feel called to start hiding their money under their mattresses.

What are the chances of the cash rate going into negatives?

The RBA has indicated it does not want rates to fall into negative territory, but there is still a chance this may happen, as it has in many other countries across the globe.

Central banks in countries like Japan, Switzerland, Sweden, Denmark and the European Central Bank have all cut rates into the negatives before. These drastic measures were taken in an effort to bolster struggling economies.

However, central banks, like the RBA, are not quick to push the negative cash rate button. Negative cash rates will significantly impact our banks’ profitability, and everyday Aussies, faced with the potential of having to pay to keep money in savings accounts, may withdraw funds en masse.

Regardless, RBA deputy governor, Guy Debelle, has stated that further cuts to the cash rate may be a possibility.

“Given the outlook for inflation and employment is not consistent with the Bank's objectives over the period ahead, the Board continues to assess other policy options,” Mr Debelle said.

Westpac’s chief economist, Bill Evans, previously predicted a rate cut next Tuesday, however, has since backtracked just today. Westpac now states that we may see a cut in early November.

While they may not immediately cut it to zero, we could be seeing the cash rate fall as low as 0.15 per cent or 0.10 per cent. And with only three board meetings left this calendar year, we could be seeing rate changes sooner rather than later.

Negative interest rates and your home loan

If you have a fixed rate home loan and the cash rate plunged below zero, very little will happen to you until this fixed period is over. However, for borrowers on variable mortgages, your repayments may change dramatically.

Ideally, your lender will pass on the full rate cut, meaning your mortgage interest rate will fall as much as the RBA cut the cash rate. If your home loan was on a rate of, say, 3.20 per cent, a cut of 15 basis points would bring it down to 3.05 per cent.

While this may seem small, on a $500,000 loan with 25-years remaining, this would be a savings of $49 a month, and $588 in the first year (excluding fees). In a time when every dollar counts, a rate cut can mean good news for borrowers.

But could your interest rate also fall into negatives – meaning your lender pays you to have a mortgage?

Something similar happened in Denmark, in which Jyske Bank launched the world’s first negative interest rate mortgage. The Danish bank offered a rate of -0.5 per cent, however borrowers weren’t being paid to have a mortgage. In fact, when you factored in fees and costs, borrowers were still paying additional charges on the loan’s principal.

It’s unlikely rates will fall so low that this occurs in Australia. But if rates do cut, and your bank doesn’t pass it on in full, it may be worth comparing which other low rate options are out there.

Negative interest rates and your savings

The most unknown change for your finances may come to the humble savings account and term deposit.

With the cash rate currently at 0.25 per cent, interest rates on savers are at rock-bottom, with the rates of many accounts already sitting under 1 per cent. It’s no secret that even the most diligent saver will get very little return on their nest egg with rates like this. But could savings accounts fall into negative interest rates?

Without a crystal ball, it’s difficult to say. While your provider may not move to charge you interest for the privilege of having a bank account, savings account or term deposit, you may find yourself paying an ongoing fee that does just this.

When interest rates fall to such severe lows, and if the RBA were to cut the cash rate into the negatives, we may see a spike in worried deposit-holders withdrawing their cash and keeping it in under the mattress or in locked safes to avoid any costs.

Unfortunately, not only are your rainy-day funds far less secure at home than in a bank, it is much less convenient to access them once you cannot use your debit card or digital wallet. With COVID-19 restrictions prohibiting the use of cash, you may find yourself unable to pay for goods and services.

For now, it may be worth keeping an eye on the cash rate and considering regular financial health checks. If you are not getting the best possible financial products for your budget and financial situation, consider if switching to more competitive options may suit you better.

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This article was reviewed by Senior Journalist Tony Ibrahim before it was published as part of RateCity's Fact Check process.

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Learn more about home loans

What happens to my home loan when interest rates rise?

If you are on a variable rate home loan, every so often your rate will be subject to increases and decreases. Rate changes are determined by your lender, not the Reserve Bank of Australia, however often when the RBA changes the cash rate, a number of banks will follow suit, at least to some extent. You can use RateCity cash rate to check how the latest interest rate change affected your mortgage interest rate.

When your rate rises, you will be required to pay your bank more each month in mortgage repayments. Similarly, if your interest rate is cut, then your monthly repayments will decrease. Your lender will notify you of what your new repayments will be, although you can do the calculations yourself, and compare other home loan rates using our mortgage calculator.

There is no way of conclusively predicting when interest rates will go up or down on home loans so if you prefer a more stable approach consider opting for a fixed rate loan.

How long can you fix a home loan rate for?

Most lenders should let you fix your interest rate for anywhere between one and five years. While rare, a few lenders may offer fixed rate terms for as long as 10 years.

Fixing your home loan interest rate for a longer term can keep your budgeting fairly straightforward, as you shouldn't have to factor in changes to your mortgage repayments if variable rates change, such as when the Reserve Bank of Australia (RBA) changes its rates at its monthly meeting. Additionally, if variable rates rise during your fixed rate term, you can continue to pay the lower fixed rate until the fixed term ends, potentially saving you some money.

Of course, a longer fixed term also means a longer length of time where you may have less flexibility in your home loan repayments. It’s also a longer period where you won’t be able to refinance your mortgage without paying break fees. If variable rates were to fall during this period, you may also be stuck paying a higher fixed rate for a longer period.

What is a variable home loan?

A variable rate home loan is one where the interest rate can and will change over the course of your loan. The rate is determined by your lender, not the Reserve Bank of Australia, so while the cash rate might go down, your bank may decide not to follow suit, although they do broadly follow market conditions. One of the upsides of variable rates is that they are typically more flexible than their fixed rate counterparts which means that a lot of these products will let you make extra repayments and offer features such as offset accounts.

What is the difference between a fixed rate and variable rate?

A variable rate can fluctuate over the life of a loan as determined by your lender. While the rate is broadly reflective of market conditions, including the Reserve Bank’s cash rate, it is by no means the sole determining factor in your bank’s decision-making process.

A fixed rate is one which is set for a period of time, regardless of market fluctuations. Fixed rates can be as short as one year or as long as 15 years however after this time it will revert to a variable rate, unless you negotiate with your bank to enter into another fixed term agreement

Variable rates is that they are typically more flexible than their fixed rate counterparts which means that a lot of these products will let you make extra repayments and offer features such as offset accounts however fixed rates do offer customers a level of security by knowing exactly how much they need to set aside each month.

What is the difference between fixed, variable and split rates?

Fixed rate

A fixed rate home loan is a loan where the interest rate is set for a certain amount of time, usually between one and 15 years. The advantage of a fixed rate is that you know exactly how much your repayments will be for the duration of the fixed term. There are some disadvantages to fixing that you need to be aware of. Some products won’t let you make extra repayments, or offer tools such as an offset account to help you reduce your interest, while others will charge a significant break fee if you decide to terminate the loan before the fixed period finishes.

Variable rate

A variable rate home loan is one where the interest rate can and will change over the course of your loan. The rate is determined by your lender, not the Reserve Bank of Australia, so while the cash rate might go down, your bank may decide not to follow suit, although they do broadly follow market conditions. One of the upsides of variable rates is that they are typically more flexible than their fixed rate counterparts which means that a lot of these products will let you make extra repayments and offer features such as offset accounts.

Split rates home loans

A split loan lets you fix a portion of your loan, and leave the remainder on a variable rate so you get a bet each way on fixed and variable rates. A split loan is a good option for someone who wants the peace of mind that regular repayments can provide but still wants to retain some of the additional features variable loans typically provide such as an offset account. Of course, with most things in life, split loans are still a trade-off. If the variable rate goes down, for example, the lower interest rates will only apply to the section that you didn’t fix.

What are the different types of home loan interest rates?

A home loan interest rate is used to calculate how much you’ll pay the lender, usually annually, above the amount you borrow. It’s what the lenders charge you for them lending you money and will impact the total amount you’ll pay over the life of your home loan. 

Having understood what are home loan rates in general, here are the two types you usually have with a home loan:

Fixed rates

These interest rates remain constant for a specific period and are a good option if you’re a first-time buyer or if you’re looking for a fixed monthly repayment. One possible downside of a fixed rate is that it may be higher than a variable rate. Also, you don’t benefit from any lowering of interest rates in the market. On the flip side, if rates go up, your rate won’t change, possibly saving you money.

Variable rates

With variable interest rates, the lender can change them at any time. This change can be based on economic conditions or other reasons. Changes in interest rates could be beneficial if your monthly repayment decreases but can be a problem if it increases. Variable interest rates offer several other benefits often not available with fixed rate home loans like redraw and offset facilities and free extra repayments. 

Does the Home Loan Rate Promise apply to discounted interest rate offers, such as honeymoon rates?

No. Temporary discounts to home loan interest rates will expire after a limited time, so they aren’t valid for comparing home loans as part of the Home Loan Rate Promise.

However, if your home loan has been discounted from the lender’s standard rate on a permanent basis, you can check if we can find an even lower rate that could apply to you.

When does Commonwealth Bank charge an early exit fee?

When you take out a fixed interest home loan with the Commonwealth Bank, you’re able to lock the interest for a particular period. If the rates change during this period, your repayments remain unchanged. If you break the loan during the fixed interest period, you’ll have to pay the Commonwealth Bank home loan early exit fee and an administrative fee.

The Early Repayment Adjustment (ERA) and Administrative fees are applicable in the following instances:

  • If you switch your loan from fixed interest to variable rate
  • When you apply for a top-up home loan
  • If you repay over and above the annual threshold limit, which is $10,000 per year during the fixed interest period
  • When you prepay the entire outstanding loan balance before the end of the fixed interest duration.

The fee calculation depends on the interest rates, the amount you’ve repaid and the loan size. You can contact the lender to understand more about what you may have to pay. 

Cash or mortgage – which is more suitable to buy an investment property?

Deciding whether to buy an investment property with cash or a mortgage is a matter or personal choice and will often depend on your financial situation. Using cash may seem logical if you have the money in reserve and it can allow you to later use the equity in your home. However, there may be other factors to think about, such as whether there are other debts to pay down and whether it will tie up all of your spare cash. Again, it’s a personal choice and may be worth seeking personal advice.

A mortgage is a popular option for people who don’t have enough cash in the bank to pay for an investment property. Sometimes when you take out a mortgage you can offset your loan interest against the rental income you may earn. The rental income can also help to pay down the loan.

What are the features of home loans for expats from Westpac?

If you’re an Australian citizen living and working abroad, you can borrow to buy a property in Australia. With a Westpac non-resident home loan, you can borrow up to 80 per cent of the property value to purchase a property whilst living overseas. The minimum loan amount for these loans is $25,000, with a maximum loan term of 30 years.

The interest rates and other fees for Westpac non-resident home loans are the same as regular home loans offered to borrowers living in Australia. You’ll have to submit proof of income, six-month bank statements, an employment letter, and your last two payslips. You may also be required to submit a copy of your passport and visa that shows you’re allowed to live and work abroad.

Why does Westpac charge an early termination fee for home loans?

The Westpac home loan early termination fee or break cost is applicable if you have a fixed rate home loan and repay part of or the whole outstanding amount before the fixed period ends. If you’re switching between products before the fixed period ends, you’ll pay a switching break cost and an administrative fee. 

The Westpac home loan early termination fee may not apply if you repay an amount below the prepayment threshold. The prepayment threshold is the amount Westpac allows you to repay during the fixed period outside your regular repayments.

Westpac charges this fee because when you take out a home loan, the bank borrows the funds with wholesale rates available to banks and lenders. Westpac will then work out your interest rate based on you making regular repayments for a fixed period. If you repay before this period ends, the lender may incur a loss if there is any change in the wholesale rate of interest.

What is a comparison rate?

The comparison rate is a more inclusive way of comparing home loans that factors in not only on the interest rate but also the majority of upfront and ongoing charges that add to the total cost of a home loan.

The rate is calculated using an industry-wide formula based on a $150,000 loan over a 25-year period and includes things like revert rates after an introductory or fixed rate period, application fees and monthly account keeping fees.

In Australia, all lenders are required by law to publish the comparison rate alongside their advertised rate so people can compare products easily.

How much of the RBA rate cut do lenders pass on to borrowers?

When the Reserve Bank of Australia cuts its official cash rate, there is no guarantee lenders will then pass that cut on to lenders by way of lower interest rates. 

Sometimes lenders pass on the cut in full, sometimes they partially pass on the cut, sometimes they don’t at all. When they don’t, they often defend the decision by saying they need to balance the needs of their shareholders with the needs of their borrowers. 

As the attached graph shows, more recent cuts have seen less lenders passing on the full RBA interest rate cut; the average lender was more likely to pass on about two-thirds of the 25 basis points cut to its borrowers.  image002

What is a honeymoon rate and honeymoon period?

Also known as the ‘introductory rate’ or ‘bait rate’, a honeymoon rate is a special low interest rate applied to loans for an initial period to attract more borrowers. The honeymoon period when this lower rate applies usually varies from six months to one year. The rate can be fixed, capped or variable for the first 12 months of the loan. At the end of the term, the loan reverts to the standard variable rate.