Negative interest rates: how they would affect mortgages and finances

With negative interest rates a real possibility, find our what the implications would be for you if you're a mortgage holder – or a first-time buyer

negative interest rates
(Image credit: Getty)

Negative interest rates could become a reality in the UK following the release of Bank of England monetary policy committee’s meeting minutes. While the BoE isn't implementing a negative interest rate just yet, keeping the base interest at just above zero – 0.1 per cent – several banks are now talking about a real possibility of a negative rate in about six months. In fact, Bank of England policymakers are now supportive of the move, which could be made in the coming months. 

What would such a drastic measure mean for mortgages, whether you currently hold one or hope to get one as part of your first house purchase? 

Negative interest rates: why might they happen?

Until recently, negative interest rates were considered to be a near-impossibility, but it is increasingly being defended by Bank of England policymakers as a way to stimulate the economy, which officially entered a recession in August. Basically, when the base interest rate is in the negative, banks are charged for holding money, which in turn encourages banks to lend rather than hold deposits.

More lending means more spending (at least in theory) and more loans for business. In practice, implementing negative interest rates doesn't always have this desired effect, which is why a BoE negative interest rates is still only a proposal. Sometimes, people actually interpret negative interest rates as a sign that they need to reign in their spending – the opposite of the effect the move is meant to create.   

Negative interest rates: what would they mean for first-time buyers? 

Obviously, a negative interest rate is bad news for savers – in fact, it is likely that those with savings accounts would be saddled with fees passed on by banks now required to pay for holding deposits. This will be a blow to those who are already struggling to put together enough for a deposit. 

Having said that, losing money on your savings during negative interest rates is not a given; in the past, some banks have chosen not to change interest rates for those whose savings accounts are in credit, up to a certain amount held. So, paradoxically, those with smaller savings pot may be more protected from the adverse effects of negative interest rates more than those with larger savings pots. 

Moreover, if the current recession results in a rise in inflation, then people's savings would diminish even further because of the reduced purchasing power of their money. In other words, living costs will rise as the value of savings in real terms (i.e. in terms of what you can actually buy with them) will diminish. 

The solution? Our advice to you if you are saving for a deposit (and even if you're not) is to look into opening an ISA account – or preferably multiple investment/stocks and shares accounts. Do this soon, because investment profits take time to mature. You won't get immediate returns, so think of this as a longer-term (five years plus) strategy. 

Negative interest rates: will my existing mortgage payments change?

If you're on a fixed-term deal, nothing will change. If you are on a standard variable mortgage, you may see a modest reduction in your mortgage payments if a negative interest rate is implemented. However, lenders tend to safeguard themselves against overly dramatic repayment reductions by putting clauses in the mortgage contracts that limit the extent to which your mortgage rate will be affected by reductions in the base interest rate.

Drastically slashing mortgage interest rates would put many smaller lenders out of business as they simply wouldn't get enough of a return on the home loans to keep afloat. Bigger lenders may well reduce some of their rates, and we may see a situation where variable rate mortgages are once again competitive against fixed rate mortgages. This will ultimately mean more choice for borrowers coming to an end of a fixed-term deal. 

Low interest rates – and even negative rates – are always good news for existing mortgage holders with a good amount of equity already built up hoping to remortgage to a better deal. We've teamed up with mortgage experts Habito – use their free mortgage comparison tool below to see what deal is best for you if your mortgage term is almost up.

Read more: