If you are a home loan borrower, I am sure you have been frustrated by your bank not passing the interest rate cuts to you. Every new iteration of loan benchmark (PLR, Base Rate, MCLR) gives you renewed hope, but nothing seems to change. Now, there is enthusiasm about Repo rate linked home loans. Though I am optimistic, we will see how this pans out. While we are worrying about saving a few basis points on our home loans, a bank in Denmark is paying borrowers to take a home loan.
Yes, that’s true.
Jyske Bank, one of the largest banks from Denmark, has started to offer home loans at -0.5% p.a. Yes, a negative rate of interest. Technically, it is an add-on loan to an existing home loan (mortgage). While it is not a mortgage in the purest sense, it is still a negative interest rate loan.
Though we are nowhere close to negative interest rate home loans, it is still interesting to understand how such loans would work.
How a Negative Interest Rate Home loan would work?
In a positive interest rate home loan, you pay interest to the bank. In a negative interest home loan, would the bank pay interest to you? Well, it can. However, that is not how I would expect that to happen. We can look at the repayment structure of the loan offering from the Jyske Bank.
Let’s say you take a loan of Rs 50 lacs for 20 years. The interest rate is -0.5% p.a. I plugged in these values in Excel PMT function to calculate an EMI of Rs 19,804.
Over the 20 years, you will pay a total of Rs 19,804 X 20 years X 12 months = Rs 47.53 lacs. Remember you took a loan of Rs 50 lacs.
As you can see, every month, the principal outstanding falls more than EMI itself.
Why?
To understand this, let’s look at how EMI calculations work.
In a regular reducing balance home loan, a portion of the EMI goes towards the interest payment and the remaining portion goes towards the principal repayment.
Interest Payment for the month = Outstanding principal at the beginning of the month * Interest rate/12
Principal payment for the month = EMI – Interest Payment for the month
Principal Outstanding at the end of the month = Principal outstanding at the beginning of the month – Principal Repayment for the month
Since the interest rate is positive, the interest payment is positive, and the principal repayment is less than the EMI amount. I have explained how these calculations work in detail in this post.
A negative interest rate mortgage is also a reducing balance loan. The difference is that the interest payment for the month will be negative. That will reflect in the principal outstanding going down by more than the EMI amount.
Remember, the more negative the interest rate, the lesser you will have to pay to close the loan. For instance, had the interest rate been -1%, you would have to pay only ~ Rs 45 lacs over 20 years to close a Rs 50 lacs loan.
Why would a bank give you a loan at a negative rate of interest?
How would the bank make money?
These are some of the questions that would come to your mind.
By the way, Government bond yields in some of the developed countries are already negative. The Government bonds are essentially loans that the investors make to the Governments. Therefore, the concept of negative interest rates loans is not new per se.
In a negative interest rate mortgage, the bank is the investor and you are the borrower. In this case, Jykse bank has said that it can raise money from institutional investors at an even lower rate and is simply passing on the benefit to investors. By the way, there are lenders in Denmark that are already offering 20-year mortgage at 0% and 30-year mortgage at 0.5%. Jykse bank has just crossed the Lakshmanrekha (and not by much).
I do not understand much economics but this short post on Investopedia will give you an idea about why investors may be interested in negative yields. To give you some perspective, the inflation in Denmark is about 1%. Negative interest rates (loan you give to the bank) on deposits can also be a disincentive to savings. The policymakers may want you to spend the money and not save.
With banks, it is never that simple
The interest rates are negative. However, there may still be other charges such as processing fee.
As per Jyske Bank website, for a mortgage of DKK 250,000, you will have to pay 277,392 towards the loan. So, the net cost to the investor is not negative (as was the perception) although it is still quite low.
I have limited knowledge about their tax laws and the banking culture. Hope a negative interest rate is not used as a negotiation level to push expensive third-party products.
Source: EmiCalculator.net
2 thoughts on “How a Negative Interest Rate Home Loan would work?”
Just to add some perspective : Logically speaking, in a high inflationary economy (and hence positive interest rates), money in circulation loses value over time and hence a rational person is better off stocking goods like rice, vegetables, gold, cotton etc (ignoring the stokcing, Perishability, and safety concerns) than keeping money idle or with banks. So Banks and govt. have to incentivise the investors to keep their money with them for their deployment. It’s the other way round in deflating or less inflationary economy (and hence negative rates). In the later case, govt. wants more money in circulation and increase the spending by its citizens to push up the inflation by punishing the cash borders in bonds and savings accounts with a penalty in the form of negative interest rates. Still, many people want to save the money by postponing their spenind (as prices are coming down to deflation) to future. Think of a scenario where you want to buy a 50L house which is expected to come down by 2% by next year and one will still be better off keeping 50L in a bond or savings account at -1% and buying house after a year. Here cash is gaining value over the goods and services. In this particular case of Denmark, the savings rate banks give is -0. 6% for short term and much lower for long term deposits. After all, bank cannot deploy this government at lower rates than giving -0. 5% or 0% loans to customers. One may think that if these countries may be better off by giving loans abroad like in India. But look at their weaking currencies(see EUR depreciation over the years) which will off shoot the yileds again back to negative when adjusted to home currency. Moreover, there might be local govt regulations for not to divert entire capital or local money to abroad. In a nutshell, too much inflation or too less inflation is not good for economy. That’s why pundits say “Inflation is a necessary evil”. We are (un)fortunate to see the practical implications of this statement in our generation after looking at Zimbabwe, Venizula and Euro zone economies in last 10 years.
Agree. Negative yields are for a reason.
Btw, even in an inflationary regime, it might make sense to stock up goods (ignoring perishability and other practical reasons to not do so) if the real rates are negative.