Negative Borrowing Rates – Can’t Happen, Right?

In Denmark, it actually happened! You borrow money, pay no interest, and collect a premium to boot. However, as an investor, you pay the bank to hold your money. Keeping it under your mattress and getting a zero return is a better option. Can this happen in the U.S.?

Last week, I asked one of our financial advisors if our financial planning software could handle amortizations for mortgages with negative interest rates. Turns out our software (comprehensive, complete with all the bells and whistles, not available in stores) could handle a positive 0.01% rate, but not a negative 0.01% rate.

So I googled “mortgage calculator.” I tried at least five different online calculators and not one of them was able to compute a monthly payment for a mortgage with a negative interest rate. I did find one calculator that could calculate a payment on a simple loan with a negative rate: my old-school TI BA-35 Solar, which retailed for about $15 twenty years ago.

Not a big deal though, despite rates being historically low, loans will never have a negative interest rate. No one is going to pay you to borrow money from them! Hold on a minute…

“You’re Going to Pay Me to Borrow Money from You?”

Sounds like an offer Don Corleone couldn’t refuse.

In an article for the Wall Street Journal, Charles Duxbury and David Gautheir-Villars wrote about a Danish family that received the equivalent of $38 as interest with their recent mortgage statement. Their variable mortgage rate was negative 0.0562%.

A bank in Denmark was paying them interest to loan them money.

As odd as it sounds, the concept is very simple. In Denmark, along with a few other countries (mostly European), central banks have lowered their benchmark rates to below zero. For loans that are tied to these benchmark rates, the loan rates are also lowered accordingly. If the benchmark rate falls enough, the loan rates can turn negative.

In the U.S., many variable rate loans, like home equity loans, are tied to the prime interest rate. Prime is about 3% above the Federal Reserve’s federal funds rate. Today, prime is 3.5%. Should the Federal Reserve lower the federal funds rate enough, some loans could eventually turn negative in the U.S.

It would be very unlikely that we will see negative borrowing rates for loans. Of course, that’s probably what someone would have said in Denmark three years ago.

How Does this Work?

A hypothetical example: a bank in Denmark “borrows” money from the central bank and because rates are negative, is paid 2%. They “loan” money in a mortgage and pay the mortgagor 0.5%. The bank makes 1.5% on the loan. In this case, the cash loser is the central bank. However, the central bank is willing to do this with the intention that the negative interest rates will spur loan demand and cause economic activity to accelerate. This would allow the central bank to increase rates back into positive territory and back to “normal.”

Can it Backfire?

What if negative rates do not spur economic activity? This is a big risk. If the central bank continues to maintain negative rates, possibly pushing them lower and consumers do not borrow to spend and businesses do not borrow to invest, then the economy does not grow. In that event, there is probably significant deflation and everyone is holding cash. Then everyone would be going to the mattresses to stuff their money, which would perpetuate the vicious cycle. The economy would be in rough shape until growth eventually accelerated.

For us in the U.S., there is nothing to worry about. Negative interest rates will never happen. Right?

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