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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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.

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 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.

What is the best interest rate for a mortgage?

The fastest way to find out what the lowest interest rates on the market are is to use a comparison website.

While a low interest rate is highly preferable, it is not the only factor that will determine whether a particular loan is right for you.

Loans with low interest rates can often include hidden catches, such as high fees or a period of low rates which jumps up after the introductory period has ended.

To work out the best value for money, have a look at a loan’s comparison rate and read the fine print to get across all the fees and charges that you could be theoretically charged over the life of the loan.

What is a standard variable rate (SVR)?

The standard variable rate (SVR) is the interest rate a lender applies to their standard home loan. It is a variable interest rate which is normally used as a benchmark from which they price their other variable rate home loan products.

A standard variable rate home loan typically includes most, if not all the features the lender has on offer, such as an offset account, but it often comes with a higher interest rate attached than their most ‘basic’ product on offer (usually referred to as their basic variable rate mortgage).

Do mortgage brokers need a consumer credit license?

In Australia, mortgage brokers are defined by law as being credit service or assistance providers, meaning that they help borrowers connect with lenders. Mortgage brokers may not always need a consumer credit license however if they’re operating solo they will need an Australian Credit License (ACL). Further, they may also need to comply with requirements asking them to mention their license number in full.

Some mortgage brokers can be “credit representatives”, or franchisees of a mortgage aggregator. In this case, if the aggregator has a license, the mortgage broker need not have one. The reasoning for this is that the franchise agreement usually requires mortgage brokers to comply with the laws applicable to the aggregator. If you’re speaking to a mortgage broker, you can ask them if they receive commissions from lenders, which is a good indicator that they need to be licensed. Consider requesting their license details if they don’t give you the details beforehand. 

You should remember that such a license protects you if you’re given incorrect or misleading advice that results in a home loan application rejection or any financial loss. Brokers are regulated by the Australian Securities & Investment Commission (ASIC), as per the National Consumer Credit Protection (NCCP) Act. 

What are the responsibilities of a mortgage broker?

Mortgage brokers act as the go-between for borrowers looking for a home loan and the lenders offering the loan. They offer personalised advice to help borrowers choose the right home loan for their needs.

In Australia, mortgage brokers are required by law to carry an Australian Credit License (ACL) if they offer credit assistance services. Which is the legal term for guidance regarding the different kinds of credit offered by lenders, including home loan mortgages. They may not need this license if they are working for an aggregator, for instance, as a franchisee. In both these situations, they need to comply with the regulations laid down by the Australian Securities and Investments Commission (ASIC).

These regulations, which are stipulated by Australian legislation, require mortgage brokers to comply with what are called “responsible lending” and “best interest” obligations. Responsible lending obligations mean brokers have to suggest “suitable” home loans. This means loans that you can easily qualify for,  actually meet your needs, and don’t prove unnecessarily challenging for you.

Starting 1 January 2021, mortgage brokers must comply with best interest obligations in addition to responsible lending obligations. These require mortgage brokers to act in the best interest of their customers and also requires them to prioritise their customers’ interests over their own. For instance, a mortgage broker may not recommend a lender who gives them a commission if that lender’s home loan offer does not benefit that particular customer.

How to break up with your mortgage broker

If you find a mortgage broker giving you generic advice or trying to sell you a competitive offer from an unsuitable lender, you might be better off  breaking up with the mortgage broker and consulting someone else. Breaking up with a mortgage broker can be done over the phone, or via email. You can also raise a complaint, either with the broker’s aggregator or with the Australian Financial Complaints Authority as necessary.

As licensed industry professionals, mortgage brokers have the responsibility of giving you accurate advice so that you know what to expect when you apply for a home loan. You may have approached the mortgage broker, for instance, because you have questions about the terms of a home loan a lender offered you. 

You should remember that mortgage brokers are obliged by law to act in your best interests and as part of complying with The Australian Securities and Investments Commission’s (ASIC) regulations. If you feel you didn’t get the right advice from the mortgage broker, or that you lost money as a result of accepting the broker’s suggestions regarding a lender or home loan offer, you can file a complaint with the ASIC and seek compensation. 

When you first speak to a mortgage broker, consider asking them about their Lender Panel, which is the list of lenders they usually recommend and who may pay them a commission. This information can help you decide if the advice they give you has anything to do with the remuneration they may receive from one or more lenders.

How do I take out a low-deposit home loan?

If you want to take out a low-deposit home loan, it might be a good idea to consult a mortgage broker who can give you professional financial advice and organise the mortgage for you.

Another way to take out a low-deposit home loan is to do your own research with a comparison website like RateCity. Once you’ve identified your preferred mortgage, you can apply through RateCity or go direct to the lender.

What happens when you default on your mortgage?

A mortgage default occurs when you are 90 days or more behind on your mortgage repayments. Late repayments will often incur a late fee on top of the amount owed which will continue to gather interest along with the remaining principal amount.

If you do default on a mortgage repayment you should try and catch up in next month’s payment. If this isn’t possible, and missing payments is going to become a regular issue, you need to contact your lender as soon as possible to organise an alternative payment schedule and discuss further options.

You may also want to talk to a financial counsellor.