What happens to mortgages if interest rates go below zero?

We have been living in interesting financial times.  Over the last decade plus we have been in a financial experiment and nobody knows how the results are going to turn out.  Since the great recession we have have very unique monetary policy from the federal government.   In the wake of the financial crisis driven by the housing market the federal reserve reduced the effective interest rate to 0 and also pumped trillions of dollars into the economy in the form of quantitative easing.  The main reason the federal reserve started the Quantitative Easing experiment is because they felt that interest rates could not be lowered below 0.   Experts have always said that 0 is the lower bound for interest rates and cannot be crossed.

That was then, this is now.  We now have federal reserve members actively talking about interest rates below zero.  The International Monetary Fund also suggested that central banks including the United States government should consider allowing interest rates to drop below zero.  With the current economic concerns weakening both in the United States and in the world abroad this would normally be the time that central banks would begin to ease interest rates to lessen the impact of a recession.  There is just one problem,  central banks were not able to raise interest rates during the boom times of the last decade.  While there were a few interest rate increases the current federal funds rate sits at 2.5%.  This does not give us very far to fall before we go to zero.  The federal reserve already started cutting rates in June of this year by .25% and some expect a cut by as much as .5% in the September meeting.  If we do slip into a recession as many experts predict in the next 18 months the federal reserve will not have many proverbial bullets in the gun to lower rates before the hit the zero mark.  Here at The Reeves Team we want our clients to be prepared for any scenario.

A negative interest rate would be something many Americans never thought they would see.  It would also behave in a way that many would not expect.  For instance, people that put their money into a saving account expect a return on their account.  Even in elementary school you are taught that banks make money by taking money from depositors, paying them an interest rate and then loaning that interest rate out to others at a higher rate.  That whole model would be turned on its head.  Now imagine if you take your money to a bank and instead of the bank telling you how much per month they will pay you, they tell you how much you will be paying them for the benefit of leaving your money in the bank.  Strange times indeed.

So what does the mean for mortgages?  If we have to pay the bank to keep our money with them, they should have to pay us if we borrow it right?  Well it might not end up working out like that for consumers.  In some news that can be glass half full, or glass half empty depending on how you look at it, we do have some examples of countries that have negative interest rates that we can learn from.  Europe has been flirting with negative interest rates since 2015 and Danish banks have actually been providing loans with -.5 basis points.  This may be hard to wrap your head around but the bank is actually going to get back less money than they loaned out to the homeowner.   It will be interesting to see how this plays out, especially due to the fact that currently banks front load the interest you pay on a home so that most of the payment goes to interest in the beginning and as the life of the loan continues more money goes towards principal.

Even if the federal funds rate dips below zero it is unlikely that mortgages will follow suit as fast.  Many home buyers would jump for joy at rates around 1% or lower, and it would be hard to convince the majority of banks to lend money to consumers basically for free.

Do you think we will see mortgage rates in the United States fall below zero?  Or is this all just hypothetical and things will continue on as they have?  Let us know in the comments below.

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