Never, since the Bank of England (BoE) was established in 1694, has the UK base rate of interest been so low. It has sat at 0.1% since early 2020, having been cut in response to the economic stress of the Covid-19 pandemic. This has been a boon to mortgage holders, who have enjoyed a knock-on effect of lower mortgage rates, but a juggling act for first-time buyers or anyone looking to remortgage and wondering which way rates will move next.
However, there’s still the possibility that interest rates could go down further still - into negative territory. The most recent quarterly Monetary Policy Committee report, published in early February, asks banks to make plans for the possibility of negative interest rates in July.
It’s a fallback position, only to be implemented if the forecast economic recovery doesn’t materialise as the UK economy slowly opens up. Nonetheless, it does raise some interesting questions for anyone with a mortgage.
What’s the point of a negative base rate?
In general, when interest rates are reduced by the central bank the aim is to get money flowing out of bank accounts (because it’s less attractive to hold savings) and into the economy in the form of spending, loans and mortgages (because it’s become cheaper to borrow money).
Azad Zangana, senior economist and strategist at investment manager Schroders, explains: “If interest rates are cut so far that they fall below zero, this theory should still apply: negative rates should encourage borrowing and discourage deposits and savings. But, in practice, negative interest rates can result in some bizarre outcomes – for both savers and mortgage holders.”
What would a negative or 0% base rate mean for mortgages?
The possibility of 0% or negative rates raises the question for banks and building societies of whether they would need to consider charging saver to hold their cash, instead of paying them interest on their savings. Savings rates are already at rock-bottom – our recent look at the top cash Isa rates found that the best accounts pay just 0.4% - but paying a bank to hold your cash would be a new concept for savers.
If that happened, the risk would be that customers simply stop holding their cash in the bank and keep it “under the mattress” instead. That would have a knock-on effect, reducing the amount banks were able to lend out to mortgage borrowers.
In practice, says Zangana, where negative interest rates have been implemented elsewhere in the world, banks have been reluctant to charge savers directly, choosing instead to increase banking fees. “If they cannot do this, then some banks have simply reduced lending, which may be the worst possible outcome given the policy’s intention is to stimulate business activity,” she adds.
Could mortgage rates go negative?
It can happen. “In some European countries, where central bank rates have been below zero for several years, mortgages at sub-zero rates – or “reverse-charging” – are no longer so unfamiliar,” Zangana says.
In other words, if your mortgage comes with a negative interest rate, you’ll end up paying back less than you borrowed. This does not mean the bank actually pays its mortgage borrowers each month, however. Instead, it progressively reduces your outstanding debt, thereby enabling you to speed up the process of clearing it. “Clearly, where interest rates are negative, there is little incentive for the mortgage borrower to repay debt,” he adds.
How likely is it that tracker mortgage rates go negative in the UK?
Not very likely, according to David Hollingworth, associate director at L&C Mortgages, even if the base rate goes negative.
“First, most trackers track the base rate plus a set margin, so there wouldn’t be a negative rate even once that was applied,” he explains. “Secondly, lenders usually stipulate a minimum rate payable by borrowers. In some cases that may stop at close to 0%, so if rates fell far enough it could see borrowers benefit to a degree – but not to the extent of being paid by the bank.”
Hollingworth adds that many trackers now have an explicit “collar” or “floor” on their tracker rate, which limits the benefit that borrowers will feel from any rate cuts. “This will put a hard stop on how low the mortgage rate could fall, irrespective of the depth of cut in the base rate,” he says.
Could other types of mortgage be affected?
Lenders’ standard variable rates (SVRs), and deals involving rates discounted from SVR, could also stand to gain from a drop in rates. However, unlike tracker deals, these rates are not directly pegged to base rate.
As Hollingworth explains, this means that although lenders will often apply changes to their SVR after a rate cut, “there is no guarantee that they will cut by the full amount, or even cut at all” – and that applies in the event of base rates falling to or below zero as well.
In practice, most borrowers over the recent period of ultra-low and largely stagnant rates have opted for one of the many attractive fixed rate deals available. These shield them from the risks posed by rising rates, but similarly by definition will not be affected by rates falling further.
“Given that borrowers will largely like the idea of knowing where they stand, the uptake of fixed rates has often been in excess of 90% of borrowers, so many will not feel the impact of any rate change whether it’s negative or upwards,” adds Hollingworth.
