Why are interest rates negative in some countries?
2 min read.Updated: 15 Aug 2019, 01:15 AM ISTVivek Kaul
Interest rates in a few countries in Europe, including Sweden and Denmark, have been in negative territory. This basically means that these countries are sloshing with money and the money is really not in demand
Jyske Bank, Denmark’s third-largest lender, is offering a 10-year home loan at an interest rate of -0.5% a year. Another bank in Denmark, Nordea, plans to offer a 20-year fixed interest rate home loan at 0% interest and a 30-year home loan at 0.5%. Mint analyses why.
1. What does a negative interest rate really mean for borrowers?
When someone borrows money, he usually pays interest on it to the bank. Hence, when the rate of interest is negative, the bank should be paying the borrower. The reality, at least in the case of the Jyske Bank home loan, is slightly more complicated. Basically, the borrower will repay the loan to the bank, and every time he pays, the amount of home loan outstanding will be reduced by an amount higher than what he repays. The borrower needs to pay an initial fee to the bank as well. Therefore, net-net, Jyske Bank’s home loan is slightly different from what it seems to be.
2. Can we understand how negative rates work through an example?
As the FAQ on this specific home loan on Jyske Bank’s website points out, let’s consider a loan of 2,50,000 Danish krone to be repaid over a period of 10 years, in 40 quarterly instalments. The total repayments work out to 2,77,392 Danish krone. This, despite the fact that the rate of interest on the loan is negative. So, the banking and other fee adds up to quite a bit. In that sense, the borrower is not paid money to borrow. At the same time, he repays only around 11% over and above what he had borrowed. This basically means that he is getting the home loan at almost 0% rate of interest.
3. Isn’t a 10-year repayment period a little too short in the case of a housing loan?
The loan is an additional home loan and can be used for home improvements like adding a new kitchen, bathroom or garage.
4. In general what is the trend of negative interest rates all about?
Interest rates in a few countries in Europe, including Sweden and Denmark, have been in negative territory. This basically means that these countries are sloshing with money and the money is really not in demand. The economies have slowed down big time in the aftermath of the financial crisis and even 11 years later, aren’t growing much. Hence, banks by offering a negative rate of interest on their deposits are telling consumers, “don’t come to us; go and spend the money".
5. Is there anything else one needs to know about negative rates?
Let’s say your wealth is in land, you need to pay people to maintain it and pay a property tax. If it’s in mutual funds, you pay a fee whether or not your investment makes money. Along similar lines, banks in certain parts of Europe are looking at money deposited with them as wealth, which is pretty abundant right now and hence, they want to charge for holding it. This explains the negative rates of interest on offer.
Vivek Kaul is an economist and the author of the Easy Money trilogy.