B1 Podcast series – Negative interest rates

Damon: Welcome to today’s LTC podcast, I’m Damon and today I’m talking to Mike about negative interest rates. Hello Mike.

Mike: Hello Damon.

Damon: So this was quite a surprising story I came across, negative interest rates. I read about a bank in Denmark that now offers negative interest loans to its customers. I guess we should start at the beginning and I was wondering if you could tell me a little bit about interest rates in general.

Mike: Yes, right, well an interest rate is how much money a borrower pays back on a loan or their debt in addition to the amount borrowed. An easy way to remember the word might be that this is what makes the arrangement interesting for the lender – the person giving out the money.

Damon: Ok, I guess it’s also quite interesting to the borrower as well! How much you’re going to have to pay back for borrowing them money! That makes sense, but what’s a negative interest rate?

Mike: Well, the usual way that these things go is that the lender gets a little bit extra back as payment for lending the money. This is worked out as a percentage of the amount borrowed and the amount varies depending on who is borrowing how much money for what and if they have any securities for the loan.

Damon: Sorry, securities, can you explain what a security is in this context?

Mike: Yes, if you secure your loan against something, it means that if you can’t pay back the loan, that is – if you default, the lender will take this security instead. It might be your house, for example. Generally speaking, the more the security is worth in relation to the loan, the lower the interest you will have to pay.

Damon: Ok, so a security is basically a safety net or a guarantee for the lender, yes?

Mike: That’s right.

Damon: Ok, so, back to the interest rates, you were saying…

Mike: Yes, as I was saying, interest rates vary but they are normally positive. This is the motivation for lending out the money in the first place. A negative interest rate is when the lender actually pays the borrower to borrow the money.

Damon: So you’re telling me a negative interest rate is when the bank, for example, would pay its customer to borrow money from it? Is that right?

Mike: It sounds crazy right?

Damon: Well, yes, why on Earth would a bank pay borrowers to borrow money?!

Mike: Well, you and I would never do this, but there are a number of reasons that financial institutions like a bank might. One reason is that some savings accounts owned by very rich people or very rich companies, they may also pay negative interest, these people or these companies lose money on their savings. Some banks are passing some of this money on to their customers, this attracts more customers who might also buy other financial products from the bank and generate revenue that way. The money was essentially free for them in the first place, so they’ve lost nothing and potentially attracted a lot of customers. It’s also worth noting that while a mortgage, that is a loan to buy property such as a house, might have a slightly negative interest rate, the customer still has to pay fees to the bank and tax. They definitely don’t get the house for free and if they miss too many instalments, they will still lose it to the bank because this is the security for the loan.

Damon: Ok, so basically it’s kind of an incentive for people to borrow money from the banks?

Mike: Yep, that’s right, it brings more people through the doors with this product and that’s more people that you could potentially sell another product to.

Damon: Ok, that’s a very clever business strategy. So maybe I need to check my savings account and see if I’m actually receiving interest or paying interest on it! And maybe I should go and buy a house at the same time Mike! Would you recommend that?

Mike: Well, it’s not quite that simple, the interest rates on these loans are often unfixed. That means that if the policy at the European Central Bank changes, the economy gets better, banks can actually raise the interest. This could turn a loan that pays you a little into one where you have to pay and as mortgages often last several decades, this is actually quite likely to happen at some point in the future.

Damon: Ok, so I shall play it safe and maybe not borrow too much money just yet!

Mike: I’d say that’s a good idea Damon.

Damon: Great, thanks very much for that Mike, I’d just like to review some of the vocabulary that came up, some of the words we used to talk about negative interest rates were…

interest rate
borrower
loan
lender
securities
to default
mortgage
propert
instalments
debt

Damon: Great, thank you very much Mike.

Mike: Thank you very much Damon.

Damon: And thanks everybody for listening.