Negative interest rates: is it time to bury your money?

Negative interest rates: is it time to bury your money?

The consecutive RBA rate cuts in June and July have taken the cash rate to an historical low at just one per cent. This, coupled with Governor Philip Lowe’s comment that the RBA may reduce the cash rate to zero per cent, has raised concerns that Australia could be joining Japan, Denmark and Switzerland in negative interest rates territory.

Unsurprisingly, this news has sparked a national debate between economists, journalists and political commentators on the best way to encourage consumer spending and boost inflation. Is it through negative interest rates?

What will happen if the cash rate goes below 0%?

If the RBA introduces negative interest rates, consumers will have to pay a fee to their bank for holding their money in a savings account, whilst ‘earning money’ for taking out a loan.

In theory, negative interest rates offer a way to boost consumer spending, borrowing and investment. This is based on the assumption that savings can be damaging to the economy if they are not re-invested into the financial system. By lowering interest rates into negative territory, banks are encouraging consumers to take their money out of savings accounts to either spend or invest it.

Feeling confused? You’re not alone.

Negative interest rates can be perplexing to prospective borrowers and lifetime savers, due to the intricacies of the financial system, and the calculations needed to understand what a future with a cash rate is below zero looks like.

Paying to save

The global economy as we have come to know it is starting to shift, with negative interest rates already in play in the EU.

Back in 2014, German bank Skatbank started charging their wealthy depositors for holding their money, which is now at a rate of 0.4 per cent. This means if you wanted Skatbank to hold $100,000 for you today in a savings account, you would pay $400 for the privilege.

Paying the major banks to hold your money is an unattractive concept for consumers, and one that could signal a move away from savings accounts, and toward investments in tangible commodities, like gold. Or, potentially, this market could encourage a surge in demand for safe deposit boxes and vaults, as people decide to hold their own savings to avoid costly fees.

Negative Interest Rates -what do they mean

‘Earning money’ on loans with negative interest rates

Paying your bank to hold your money does seem in stark contrast to the idea that consumers will ‘earn money’ on loans they take out.

However, as with all financial products, you must read the fine print. Borrowers will not receive money into their account per se, but instead what they ‘earn’ will subsidise their mortgage repayments.

An example of this can be seen in the recent move by Danish lender, Jyske Bank. This lender is now offering prospective homeowners seven or ten year fixed-rate mortgages with -0.50 per cent interest rates.

In their official release, Jykse Bank confirms that investors will not receive the money directly into their accounts. Instead the negative interest rate increases the repayment to higher than it would be with a positive interest rate, and the -.50 per cent interest rate acts as a subsidy to reduce the total amount a borrower would repay.

The fact that investors will not get any physical money into their accounts, is complicated further by the addition of bank fees and contributions charged by lenders for loans of this type.

Will home loans with negative interest rates turn out to be less affordable when high repayments and fees are taken into account?

Financial calculations and discrepancies between lenders seem to create a miasma of misunderstanding over the entire debate. Truthfully, until these types of home loans are created, and fees applied, it is difficult to determine whether negative interest rate home loans will indeed be beneficial to consumers.

As such, it’s important that consumers increase their financial awareness, and educate themselves on how these changes could impact their own financial situation.

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Learn more about home loans

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 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.

Interest Rate

Your current home loan interest rate. To accurately calculate how much you could save, an accurate interest figure is required. If you are not certain, check your bank statement or log into your mortgage account.

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 'principal and interest'?

‘Principal and interest’ loans are the most common type of home loans on the market. The principal part of the loan is the initial sum lent to the customer and the interest is the money paid on top of this, at the agreed interest rate, until the end of the loan.

By reducing the principal amount, the total of interest charged will also become smaller until eventually the debt is paid off in full.

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.

Does Australia have no cost refinancing?

No Cost Refinancing is an option available in the US where the lender or broker covers your switching costs, such as appraisal fees and settlement costs. Unfortunately, no cost refinancing isn’t available in Australia.

Can I change jobs while I am applying for a home loan?

Whether you’re a new borrower or you’re refinancing your home loan, many lenders require you to be in a permanent job with the same employer for at least 6 months before applying for a home loan. Different lenders have different requirements. 

If your work situation changes for any reason while you’re applying for a mortgage, this could reduce your chances of successfully completing the process. Contacting the lender as soon as you know your employment situation is changing may allow you to work something out. 

Can I get a home loan if I am on an employment contract?

Some lenders will allow you to apply for a mortgage if you are a contractor or freelancer. However, many lenders prefer you to be in a permanent, ongoing role, because a more stable income means you’re more likely to keep up with your repayments.

If you’re a contractor, freelancer, or are otherwise self-employed, it may still be possible to apply for a low-doc home loan, as these mortgages require less specific proof of income.

Will I have to pay lenders' mortgage insurance twice if I refinance?

If your deposit was less than 20 per cent of your property’s value when you took out your original loan, you may have paid lenders’ mortgage insurance (LMI) to cover the lender against the risk that you may default on your repayments. 

If you refinance to a new home loan, but still don’t have enough deposit and/or equity to provide 20 per cent security, you’ll need to pay for the lender’s LMI a second time. This could potentially add thousands or tens of thousands of dollars in upfront costs to your mortgage, so it’s important to consider whether the financial benefits of refinancing may be worth these costs.

Is there a limit to how many times I can refinance?

There is no set limit to how many times you are allowed to refinance. Some surveyed RateCity users have refinanced up to three times.

However, if you refinance several times in short succession, it could affect your credit score. Lenders assess your credit score when you apply for new loans, so if you end up with bad credit, you may not be able to refinance if and when you really need to.

Before refinancing multiple times, consider getting a copy of your credit report and ensure your credit history is in good shape for future refinances.

I have a poor credit rating. Am I still able to get a mortgage?

Some lenders still allow you to apply for a home loan if you have impaired credit. However, you may pay a slightly higher interest rate and/or higher fees. This is to help offset the higher risk that you may default on your repayments.

I can't pick a loan. Should I apply to multiple lenders?

Applying for home loans with multiple lenders at once can affect your credit history, as multiple loan applications in short succession can make you look like a risky borrower. Comparing home loans from different lenders, assessing their features and benefits, and making one application to a preferred lender may help to improve your chances of success

Will I be paying two mortgages at once when I refinance?

No, given the way the loan and title transfer works, you will not have to pay two mortgages at the one time. You will make your last monthly repayment on loan number one and then the following month you will start paying off loan number two.