Two Danish banks introduced mortgage deals in early August that were so favorable to customers, they made international headlines.
On Aug. 7, Nordea Bank Abp announced that it would be offering 20-year fixed rate mortgages at 0%. Earlier that week, Jyske Bank A/S, one of the largest banks in the country, revealed that it would also be selling mortgages at a significantly reduced rate: for a 10-year mortgage, customers would looking at -0.5% interest. Yes, that's a minus sign.
Mortgage rates have a huge impact on how much homeowners end up paying for their homes, so it’s no surprise that a mortgage deal that’s completely free of interest charges is big news. But the earlier announcement by Jyske, which unveiled a mortgage rate that was actually negative, could not be celebrated with ease. On the one hand, it meant that Jyske was really paying its customers to take out mortgages, which seems like as good a mortgage deal as any. On the other hand, finding out that a bank is willing to flip the traditional lending script in order to secure customers was also perplexing.
When foreign banks offer negative interest rates to their customers, it’s important to pay attention. Canada’s economy doesn’t function in a vacuum, and what’s global can often have domestic implications.
Below, we offer some context for the recent news in Denmark, and tackle another question: is Canada headed in the same direction?
How do negative interest rates work?
Yes, you heard that right: if you take out a mortgage with a negative interest rate, your lender will actually pay you interest, instead of expecting you to pay them.
For homebuyers, this might seem like a win-win situation: by buying a home, you’ll be able to build equity by making your mortgage payments and letting your home accrue value. At the same time, you’re also being compensated — instead of penalized — for taking out a loan to bring this plan into motion.
Sign of a weak economy?
For lenders, negative interest rates are much less favorable. When banks want to pay you money to take out a loan, it’s typically because the economy-at-large is weakening. Economists have observed that when people and businesses are seeing slow growth in wages and revenue, they tend to hoard money instead of spending or investing it. While this might be practical from an individual perspective — good personal finance dictates that you shouldn’t spend more than you’re capable of paying for — it’s not great for the economy. In order to grow, the economy needs money to circulate. By giving customers an incentive to borrow, banks hope to encourage more people to spend and help the economy recover. In theory, negative rates are a temporary stimulant.
In recent years, negative interest rates have appeared in Japan, Switzerland and Sweden; the European Central Bank introduced negative rates in 2014.
But institutional lenders like banks are not the only ones who lose out when negative interest rates are introduced. Individual investors can also suffer.
On Wednesday, the Associated Press reported that the government of Germany sold 30-year bonds with negative interest rates. Bonds are peculiar products because they function like both an investment and a loan: if you buy government bonds, you’re essentially loaning the government money, with the expectation that you’ll eventually get that money back, and earn interest in the process. When you buy bonds with a negative interest rate, you’re still lending money to a borrower (e.g., the government) — but you’re also paying the borrower for the privilege of doing so.
The fact that the German government was able to sell bonds with a negative interest rate might seem confusing: where’s the appeal in lending an institution money, and paying them interest on top of it?
The answer lies in investor outlook. “Accepting a negative yield on a bond — agreeing, in effect, to lose money in exchange for parking money in a safe place — could reflect expectations that yields will sink even further into negative territory,” the Associated Press reported.
And when bond yields go down, prices for bonds go up. So investors buying these bonds actually expect yields to go even further down, eventually profiting in the end.
The Associated Press went on to note that the amount of worldwide debt with negative rates has soared to $16.4 trillion in August from $12.2 trillion in mid-July.
How much can you actually earn from negative rates?
The weakening of the global economy is not exactly a low price to pay for a negative rate on your mortgage, especially when you consider how little you’re actually earning.
Jyske, for example, offers a negative rate of -0.5%. That’s not exactly high to begin with. But it’s even lower when you take into account inflation, which has grown at an average rate of 1.57% between 2001 and 2019, according to economic forecasting website Trading Economics. Once that’s factored in, you’re actually losing about 1% and not earning anything at all.
Another factor to consider, particularly if your lender is a bank, is how much you’re already paying your lender in banking fees, K.C. Ma, director of the Roland George investments program at Stetson University, told The Street last year.
So while you’re getting money back from a negative rate, a bank or mortgage lender will still profit from you by embedding fees into the process. Remember, in the financial world, nothing is truly free.
Are negative rates coming to Canada?
In recent months, reports of an inverted yield curve — where investors are making more money from short-term investments than long-term investments — and trade tensions between the U.S. and China have suggested the possibility of a recession in Canada.
But the economy actually seems to be in a decent place right now. Home prices have been rising at a sustainable pace, the country has seen strong employment growth, and while household debt levels are high, most Canadians are equipped to handle them.
All that being said, it doesn’t seem that Canadians are going to be seeing negative interest rates anytime soon. But don’t be disappointed.
“As appealing as it may sound to Canadian borrowers who are still paying actual interest on their mortgages, we should not hope for the day when our lenders are paying us to take their money,” noted mortgage broker David Larock earlier this week.
“After all, they would only accept a losing proposition today if they feared an even worse one tomorrow.”