What are negative interest rates? Here’s what you need to know

Stimulus payments. Repayable loans to businesses. Federal unemployment benefits.

So many unusual policies and practices have emerged in recent months to help stabilize the economy that it seems almost anything could be on the table. Could negative interest rates be next?

Negative rates – where borrowers receive payments from lenders – have actually been around for several years, tried in limited form in Japan and a few European countries, with mixed success in boosting their economies. They have yet to materialize in any meaningful way in the United States and likely won’t, although President Trump recently posted on Twitter that he liked the idea.

Negative interest rates, in the unlikely event that they become ubiquitous, would radically change the rules of the game for savers and borrowers alike. Here are some things consumers should know:

What exactly are negative rates?

Everyone is used to paying interest when borrowing money and earning interest when depositing money. Negative interest rates would reverse the trend.

A bank might not charge savers a negative rate, but it could charge “storage fees” that exceed any positive interest earned, said Dennis Hoffman, professor of economics at Arizona State University.

This scenario would represent a “penalty for holding cash,” he said. By pushing rates ever lower, policymakers would “encourage you to get rid of the money by spending money and thereby boosting economic activity,” he said.

Interest payments on some government bonds in Japan and Europe have fallen to around zero or a little lower. Short-term T-bill yields did so recently, as low-risk investors searched for safe places to hold cash during the economy’s worst shutdown in recent weeks. They are the best example, albeit fleeting, of negative interest rates in this country. T-bills with 30-day maturities have since rebounded to positive interest rates, although they are currently only yielding around 0.1%.

Are negative rates spreading?

No. Although negative interest rates have materialized on the public debt of some countries, this remains more the exception than the rule.

The Federal Reserve has been considering a negative interest rate policy since last October but does not want to go in this direction. “The Fed has already signaled a reluctance to pursue this type of policy and (Fed Chairman) Powell mentioned that the Fed’s thinking has not changed,” JP Morgan noted in a late May comment.

But while negative rates are unlikely to become mainstream, many savers in this country earn less than zero after factoring in fees and inflation.

With deposit accounts, money market funds, and other ultra-conservative investments already earning next to nothing, it doesn’t take a lot of extra fees, or a lot of inflation, for real returns to slide into negative territory, a Hoffman said. But on a practical level, he considers it more realistic to view negative interest rates as “really low rates”.

So I won’t earn interest by borrowing money?

It’s a theoretical possibility, but don’t expect it to happen for consumers in the real world. “No one will pay you to take out a loan,” said Greg McBride, chief financial analyst at Bankrate.com.

Hoffman agrees and points to mortgage rates in countries where government bonds have turned negative. Even in these places, borrowers with mortgages and other consumer loans are still paying positive interest rates, albeit at low levels, he said.

While interest rates are notoriously hard to predict, no one is predicting negative rates on traditional consumer loans. For example, the Mortgage Bankers Association expects mortgage interest rates to average 3.4% this year and 3.5% in 2021.

Negative interest rates are much less likely for other types of consumer loans, such as credit cards and car loans. For example, most credit cards currently charge 15% and more and are therefore far from negative territory.

What credit stocks make sense now?

If you need to borrow and have decent credit, it can be beneficial to refinance or take advantage of today’s ultra low rates, even if you can’t get a lender to pay you for this privilege. .

For example, McBride suggests homeowners consider mortgage refinancing if they can save at least three-quarters of a percentage point in interest and if they expect to stay in the home long enough for their interest savings to pay off. to recover costs of origination, appraisals and other refinancing. expenses. Usually this will take a few years or so.

For savers, today’s ultra-low rate environment makes it more important to seek better deals and beware of fees which can further erode returns.

Many types of fees, including account maintenance and overdraft fees and ATM fees, were slowly rising at many banks anyway, even before the coronavirus pandemic hit, McBride said. Conversely, he noted that it’s still possible to get free checking accounts at about 40% of banks and 80% of credit unions, especially if you sign up for direct deposit.

Economists continue to debate the speed and depth of the recovery, but most see the economy resuming growth by early next year at the latest. With an economic rebound, interest rates could start to rise, relegating negative rate speculation to the background.

Contact Wiles at [email protected]

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