If you have ever applied for a mortgage loan – or any other similar type of assistance – you know that you are required to pay interest in addition to the principal. However, negative interest rates exist as well. These types of rates happen when you (the borrower) is credited interest instead of paying interest to lenders. Certain developed countries like Japan (-0.1%) and Switzerland (-0.75%) have recently implemented negative interest rates at times for a variety of reasons. Let’s examine how and when these interest rates occur.
Banks Paying You
Negative interest rates imply banks pay you interest to hold cash with them. In this case, the bank essentially pays you to take out a loan. Most people would likely agree that this sounds like an excellent deal. It’s important to note that although both high-risk and low-risk borrowers can technically be involved in a negative interest rate scenario, lenders are more likely to assist the latter type of borrower.
Environment Where It Occurs
A “negative interest rate” environment is considered one where the nominal interest rate falls below 0 percent for a given economic area. This means that lending institutions would need to pay in order to retain their excess funds that are typically kept in a central bank, as opposed to earning positive interest income.
Happens During Deflationary Periods
Negative rates generally appear during major recessions or deflationary periods (like the 2008 financial crisis or the current recession brought on by the spread of the COVID-19 virus), when people and organizations tend to save up money rather than frivolously spend or lend it. This type of behavior often leads to a significant decrease in demand, which entails a drop in prices while unemployment increases. If inflation equals 4 percent and the interest rate on a loan equals 3 percent, your lender’s return (after accounting for inflation) is negative.
Nominal Interest Rate Below Zero
During recessions, monetary policy and other market forces drive interest rates down to the nominal zero bound. An unconventional negative rate policy can trigger economic patterns that lead to the implementation of an expansionary or “loose” monetary policy. The former type of policy has been used in certain nations to spark economic growth via investment and spending. This way, depositors can have the incentive to spend cash instead of keeping it in a bank account and subsequently sustaining a loss.
One recent report by Fed officials Michael Kiley and John Roberts stated that nominal interest rates have (on average) been cut by as much as 5.5% or more to combat recessions that occurred in the United States and the euro area after 1970. When interest rates hit historic lows, policy rate cuts of this size will likely be challenging to implement going forward without causing rates to become negative.
In March, the Federal Reserve cut interest rates to zero. Additionally, all Treasury yields have dropped to their lowest levels in history at some point since then. (The yield for 10-year notes fell to 0.58% on April 21, and the yield for 30-year notes plunged to 1.17% that same day.) The federal funds rate on March 15 (0.25%) reached its lowest level since December 2018.
One of the main downsides to a negative interest rate policy is that it could potentially lead to reduced profits for lenders. This could ultimately discourage lending overall and unnecessarily decelerate the economy. This is important to keep in mind as we enter a period of great economic uncertainty.
Work with Mathis Title Company
Speak to the professionals at Mathis Title Company in Fairfax, Virginia to learn more about how negative interest rates come about and what their consequences are. Mathis is proud to serve many towns throughout Fairfax County, including Arlington, Alexandria, Chantilly, and McLean.
Robin Mathis is an attorney who has more than 30 years of experience in real estate law and services and who was sworn in to the U.S. Supreme Court. She has performed thousands of closings, both small commercial and residential, and she is highly knowledgeable about both sides (buyer and seller) of transactions. Ann Andreatos and Bronwyn Chace are talented title agents who know how to meticulously scrutinize documents and identify errors.
Our services include drawing up purchase agreements (so that your rights as a homeowner are respected), mechanics lien, refinancing, settlements, and title insurance. We will always work closely with your lending institution to ensure all aspects of your home purchase, sale, or transfer-of-ownership are handled correctly. Call Mathis Title Company today at (703) 214-4020 or contact us online for more information about our work.