Negative Mortgage Rates in the U.S.?

When it comes to taking out a loan, there’s no such thing as free money — unless you’re a Danish homebuyer, that is. This summer, a Scandinavian bank started offering mortgages with a negative interest rate, which means the lender basically pays people to borrow money from them. No doubt, it’s a bizarre situation, but it’s worth investigating how this might impact the U.S. market if negative rates came to our shores.

What are negative mortgage rates?

Typically, when you borrow money for a mortgage, the lender is going to charge you interest over the course of the loan. For example, let’s say you take out a 15-year mortgage for $200,000 at a 4% interest rate. Over the course of 15 years, you’ll pay back the $200,000 plus an extra $66,000-plus in interest.

On the other hand, when a mortgage has a negative interest rate, not only is the lender not charging you interest but they’re setting up a payment schedule where you end up paying them less than what you originally borrowed. So for that $200,000 mortgage, you might theoretically only end up paying the lender $190,000 back. In short, you could actually make a profit on this loan (not accounting for any fees or closing costs).

How do negative mortgage rates happen?

Mortgage rates are based on market-wide interest rates, which depend on the strength of a country’s economy and its monetary policy. When a country grows quickly, there’s little incentive for Central Banks to reduce interest rates due to the high rate of growth and demand for financing. 

Conversely, when an economy slows or enters a recession, interest rates can decrease as Central Banks cut rates in a bid to stimulate economic activity.

In slowing economies, private citizens and corporations alike, unwilling to invest in new productive endeavors may prefer to hoard cash instead. This can further exacerbate the problem into a “deflationary spiral,” the scourge of every Central Bank.

In countries like Denmark and Japan, economic growth can be slow for an extended period of time due to endemic factors like an aging population or a shrinking labor force. Central Banks may choose to take drastic measures to combat deflation and cut rates to below zero to revitalize their economies.

With Central Banks slashing rates to the bone and market rates following suit, investors and borrowers alike may find themselves in the twilight zone of a negative interest rate environment.

Why would lenders offer negative rates?

Crossing into the consumer lending space, this can present a challenging business environment as banks struggle to attract borrowers even at the lowest rates. 

This is precisely the reason why Jyske Bank A/S — Denmark’s third-largest bank — started offering 10-year mortgages with a negative interest rate to prime borrowers. While these rates currently yield a nominal -0.50% for qualifying borrowers, homebuyers would still be required to pay back their principal in fixed intervals over time and are still on the hook for closing costs in the short term.

Since the lenders would be charging closing costs and fees, they would still come out ahead versus just holding onto unused cash. At the same time, investors perpetuate this process by buying up these pools of mortgage bonds at phenomenally low rates, thereby continuing the cycle.

Will negative mortgage rates come to the U.S.?

Even if the Fed continues to reduce rates, it is unlikely that U.S. banks would offer negative mortgage rates in the near future. The United States has a stronger economy, a younger population and higher rates of immigration, leading to a strong demand for financing. As a result, most American banks don’t face an immediate need to slash their rates to attract consumers.

President Trump has encouraged the Federal Reserve to lower market rates in the U.S. to, or even below, zero in an effort to stimulate economic growth. While the Federal Reserve has lowered rates over the past year, its short-term target rate range is 1.75% to 2.00% as of October 21, 2019.

With that being said, the current reduction in rates has made mortgages more affordable throughout 2019. This has specifically led to a short-term boom in refinancings, with existing homeowners able to cut their mortgage rates by as much as 0.50% or more.

How might negative mortgage rates affect consumers?

In theory, negative mortgage rates make home-buying more affordable. With no money going to interest, consumers can afford larger loans and get out of debt more quickly. Consumers who already have an existing mortgage could also refinance at lower rates, saving money over the long run. However, there exist some downsides.

Higher home prices

Housing prices seem to have gone up in Denmark due to the lower interest rates, according to MarketWatch. Since homeowners can borrow larger amounts, they are spending more on homes which has led to a short term real estate boom.

This effect can be observed in the U.S. with historically low-interest rates resulting in steadily increasing home prices over the past four years. Average home prices across the United States rose by 5 – 8% per year from 2015 to 2018. While this is generally a positive for current homeowners, it raises the barriers to entry for new homebuyers. 

Restrictive lending standards

When mortgage rates are negative, it could become more difficult to qualify for a loan. Since lenders are making less money on each loan, they might not be willing to risk lending to someone with poor credit, leading to tighter underwriting standards.

This crowding-out effect can be observed at commercial lenders who staff a limited number of loan officers. This restricted supply of loan officers may be incentivized to focus on higher credit scores when faced with overwhelming loan demand. This could make it harder for both middle and working-class Americans to qualify for a home loan.

Disincentives to save

When mortgage rates are negative, chances are other interest rates will be extremely low or negative as well, including for bank accounts. Consumers could be discouraged from saving for a future down payment due to lower deposit rates.

As of the time of this writing, savings rates peaked earlier in the Spring of 2019 but fell alongside mortgage rates after the Federal Reserve began cutting interest rates halfway through the year. As it became cheaper to borrow, it becomes less attractive to save.

What does this mean for home buyers and real estate investors?

If investors tend to do cash deals to buy properties, negative rates would be an incentive for them to take out a mortgage instead. There’s no cost to borrowing so investors have a stronger motivation to take out a loan and save their cash for other investments.

Whether the negative rates will help or hurt their property investments will depend on the market conditions — prices could continue to go up as they did in Denmark. The main concern for investors would be whether these negative rates coincide with a recession, which could lead to murkier waters for all.

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