What Happens When Interest Rates are Negative?

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What Happens When Interest Rates Are Negative

As more nations are considering drastic measures, you should know what happens when interest rates are negative. The world faces impending economic collapse, so countries are now mulling over unconventional solutions. 

One of these extreme methods is requiring banks to offer negative interest rates for loans. Your country may follow suit, drastically changing your borrowing and spending experiences.

What are Negative Rates?

Surprisingly, negative rates mean your bank pays you according to your loan’s interest rate. It may sound outlandish because consumers usually pay interest, not earn interest. 

It’s also a huge revenue stream for banks that would end up in their client’s pockets instead. However, world leaders are considering this option in order to expedite economic recovery.

What Are Negative Rates

This unusual method is supposed to encourage spending by giving people more money. Some assume that people will start purchasing goods and services again, enabling businesses to recover. 

Eventually, money may increasingly exchange hands, so the economy could start flowing once more. It’s an unorthodox way of stimulating the economy that is being pondered upon during these unprecedented times.

Contrary to popular belief, it’s not an outrageous concept as other countries have been implementing it before. For example, Japan has been offering negative rates even before the pandemic. The country has been giving money to borrowers to also persuade them to spend more. However, we may need lower interest rates in order to truly restore the global economy.

What is the Impact of Negative Interest Rates?

Below-zero interest rates have various ramifications that may help or harm the economy. While it could incentivize consumer spending, it may discourage lending. 

Credit institutions may also lose profits from loans, so they may reduce the benefits they provide in savings accounts. Worse, people may keep the money instead, and it would be difficult to revert interest rates back.

May Reduce Savings Benefits

People may be receiving perks from their savings accounts depending on their chosen bank. However, negative interest rates may cause their provider to diminish those in response. 

Banks may do this to compensate for their losses from below-zero interest policies. In turn, this may discourage people from saving money.

People May Still Avoid Spending

The assumption that consumer spending will restart by giving people money is not guaranteed. In fact, people may still refuse to buy stuff even if they get more money.

People may want to prepare for the tougher times ahead, so they may hoard funds for emergencies instead. This will render the purpose of implementing negative interest rates utterly obsolete.

May Discourage Lending

Banks, credit unions, and other credit establishments earn profits from interest. It’s essentially a fee they levy on borrowers as compensation for their loans.

With negative interest rates, that revenue stream will flow in reverse. Instead of filling their coffers, negative rates will divert their money to their borrowers.

May Discourage Lending

This does not remove the risk that borrowers may neglect to repay loans on time. This is why the below-zero interest may cause banks to tighten loan terms and conditions. They will make sure that their clients are more than likely to pay their loans back diligently. 

As they won’t earn from below-zero interest, banks would need repayment more than ever.

Difficult to Return to Normal Interest Rates 

Below-zero interest rate policies will require various other rules and regulations to adapt to its implementation. Credit institutions will need a significant amount of time in order to function under this unconventional policy. 

Similarly, people will have to adjust to these new policies as well. They would have to fit their personal and business finances accordingly. New negative rate environments will make reverting back to normal interest rates rather difficult. 

This is one of the reasons why central banks are carefully planning how the new interest rates will be implemented. It would mean that credit institutions will have to amend their terms of service once more. 

Moreover, people may be reluctant for normal interest rates since they would need to adjust again.

Speaking of which, the USA has refused to implement negative federal funds rates as a viable economic solution for the COVID-19 economy. Federal Reserve chairman Jerome Powell said that he and the Fed’s policy committee refused it. 

In contrast, the European Central Bank has decided to further lower its negative rates. The institution reported that it was meant to help people and businesses during this uncertain economic period. 

Do You Lose Money with Negative Interest Rates?

You can lose money in savings due to negative rates. As we’ve mentioned, banks may compensate for them by reducing benefits from savings accounts.

They could increase the amount they charge for your account, or they can lower your earnings from it. Like most people, you might want to pull your money out of the bank in response.

How will Negative Interest Rates Affect Me?

This unusual bank policy can actually come to your advantage though. It could drastically lower interest rates, making it more favorable to borrow money. 

How Will Negative Interest Rates Affect Me

You could find your mortgages more affordable due to the below-zero interest policies. In fact, you might even enjoy shopping with credit cards due to negative interest!

How can I Prepare for Negative Interest Rates?

The implementation of negative rates in response to the COVID-19 pandemic is carefully being studied at the moment. However, it’s just one of the many proposed solutions, and it might be implemented differently for this unprecedented situation. 

After all, the policy will be discussed thoroughly, carefully considering all related factors such as government debt.

You just finished the first step of adapting to this new policy by reading our article. We recommend reading other resources regarding other proposed economic solutions. Also, check your own country’s institutions for information regarding their specific economic recovery plans. 

Keep yourself informed, so you can effectively adapt your personal finances, short-term and long-term.