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Could we soon be paid to take out a mortgage?

Andrew Bailey (illustration)
Andrew Bailey (illustration)

In March, Andrew Bailey the governor of the Bank of England said that negative interest rates were off the cards. Fast-forward two months of lockdown, economic stasis, and a forecast for the worst economic shock since 1706 and he has changed his mind. The controversial policy is now under “active review”.

British house prices are closely tied to the availability of lending. So what would negative rates mean for the housing market?

What are negative interest rates?

Central banks cut base interest rates in times of crisis to stimulate the economy.  It means that banks are charged to keep money on deposit and is designed to increase spending and business investment. If banks can’t make as much money by sitting on it, they are encouraged to lend it.

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When coronavirus hit Britain, the Bank of England had only just been starting to raise the Base Rate by tiny degrees after it had slashed it in the wake of the financial crisis. It sat at 0.75pc and was duly cut to 0.1pc. That’s a new record low, but a 0.74 percentage point cut is negligible. By comparison, the post-2008 cut was 5.25 percentage points. With the country now about to experience its worst economic shock for 300 years, more radical action may be needed.

A negative base rate is an extreme kind of stimulus. It would mean banks would have to pay the Bank of England to keep money on deposit, and so would be pushed to lend money into the economy. In what would be a first for Britain, there are concerns what effect negative rates could have on banks’ profitability. Still, the policy has proved effective in Japan, Denmark and Switzerland.

Will I be paid to take out a mortgage?

In theory, if a negative base rate was passed directly on to consumers, this would mean having to pay to keep savings in the bank and being paid to have a mortgage.

In Denmark, when the base rate dropped to -0.75pc, one bank did start offering the world’s first negative rate mortgage last summer — a 10-year fixed rate at -0.5pc. Banks in some Swiss cantons followed suit.

An April, a Deutsche Bank report concluded that it is “entirely possible” that negative mortgage rates could become a feature in the UK.

But it would not be easy. Hansen Lu of research firm Capital Economics said: “As the base rate falls, it becomes increasingly difficult for banks to pass it on to consumers because it becomes difficult for banks to fund themselves.”

They still need to be able to pay their savers to stop them from taking their money out of the bank. Note that few benefits of the March cut to 0.1pc were passed on to the mortgage market.

Nick Morrey of John Charcol, a mortgage broker, said: “The only people who might see a real benefit are people on tracker mortgages.”

However, the perks will be contract dependent. Most mortgage lenders have included a “collar rate” in their offers since 2010, said Mr Morrey. Effectively, if the base rate gets too low, it’s not passed on to consumers.

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How would negative interest rates affect house prices?

Even if a negative base rate would be unlikely to spawn mortgages that pay you to borrow, it would still increase people’s buying power.

At the end of last year, the average house price-to-earnings ratio last year was five, according to Nationwide, up from 4.4 at the end of 2009. This jump was fuelled by a decade of low interest rates, said Mr Lu. Consumers were able to buy more expensive homes despite not having proportionately higher wages because there was a decade of cheap debt in the wake of the last crisis.

“Falling rates will only increase the upward pressure on prices,” said Mr Lu. Except not just yet. First the housing market will need to work its way through the economic downturn.

“Low interest rates will not be enough to offset the impact of the recession,” said Mr Lu. But when we are out the other side the price-to-earnings ratio will likely increase. “When everyone is getting free money at the same time, prices go up.”

“That would be fantastic for people who already have a house,” said Mr Lu. “But for first-time buyers it will be worse because of the increased hurdle of a deposit.”