What are negative interest rates and how do they work?

The Reserve Bank of Australia has cut the cash rate six times in the last two years, including twice in March 2020. Right now, official interest rates sit at 0.1% — the lowest they’ve ever been. But is there a chance they could drop to zero? Or even lower?

RBA governor Philip Lowe has been quite candid about his distaste for negative interest rates. In a November speech, he said there is little to be gained by taking rates negative, and that it was “extraordinarily unlikely” the unconventional policy would be adopted in Australia. 

“While a negative rate might lead to a helpful depreciation of the Australian dollar, it could impair the supply of credit to the economy and lead some people to save more, rather than spend more,” he said.

In fact, the closest the RBA has come to saying something positive on the matter was when deputy governor Guy Debelle said the “empirical evidence on negative rates is mixed.” Not exactly a glowing endorsement.

But what would it mean if things reached the zero mark? While the RBA has tools at its disposal it would rather make use of, rates of 0% or below have been the norm for years elsewhere around the world. We take a look at how they work.

First of all, what do cuts to the cash rate mean for you?

If we look at the immediate impact on personal finances, then low interest rates paint a favourable picture for homebuyers and mortgage holders. The graph below shows how home loan interest rates have moved with each reduction to the cash rate over the past five years.

Of course, lenders aren’t obligated to pass on any cuts to their customers in full. There are plenty of factors they need to consider, such as maintaining a healthy margin between the loan and deposit rates they’re offering.

As for savers, they don’t have much to be optimistic about. Many savings accounts, particularly those from the big banks, offer ongoing rates in the zero to one per cent range already. Simply put, Australians who rely on interest as a source of income have been handed a raw deal.

While reductions to the cash rate get a lot of attention for their effect on owners and homebuyers, we shouldn’t lose sight of the fact that falling interest rates are an indicator that the economy isn’t faring too well.

Cuts are usually made in response to lacklustre growth and below target inflation and employment figures. By lowering interest rates, the Reserve Bank hopes to give the economy a much-needed shot in the arm by encouraging people to spend, borrow and invest.

This could play out in a few ways. Besides the obvious appeal of low borrowing costs, some think that if savings accounts are producing negligible returns, people will be less willing to keep their money idle in the bank and more likely to put it to use in other ways.

In reality, things are much less certain, and the effectiveness of monetary policy - particularly in the short term - is a matter of debate. This goes doubly so during crises like this one, where precautionary savings are on the rise.

How do negative interest rates work?

Commercial banks have deposit accounts with the RBA, and they receive interest on these accounts just like an ordinary Australian would on their savings account.

If official interest rates drop below zero, then all of a sudden banks will have to start paying interest to the RBA. The hope, of course, is that they will balk at the very idea, withdraw their cash reserves, and lend it out to customers instead.

While the idea is to turbocharge investment, there are plenty of ways that this might backfire in practice. For example, negative or extremely low interest rates could put a strain on banks’ profit margins, potentially reducing their willingness to lend.

And if the cash rate drops so low that consumer interest rates are dragged down with it, it could create a topsy-turvy financial environment, in which savers are charged to keep money in the bank and borrowers are potentially rewarded with interest.

Banks are wary of how this would impact consumer sentiment. E.g. if they are pushed to charge interest on deposits, customers might decide to withdraw their savings and hoard their cash at home instead, draining banks of a crucial source of financing.

In many countries where official interest rates have dipped into the negatives, banks have refrained from cutting savings rates in kind for this very reason, as in Japan, where many savings accounts offer interest rates in the range of 0.001% p.a.

Which countries have negative interest rates?

Interest rates may be close to zero in Australia, New Zealand, the US and elsewhere in the world, but plenty of countries have already crossed over into negative territory. 

Back in 2009, after the global financial crisis hit, Sweden became the first country to take official interest rates below zero, making it an important case study among economists worldwide. Other parts of Europe, such as Switzerland and Denmark, followed soon after.

Japan made headlines when it adopted negative interest rates in 2016, after multiple stimulus packages - deployed after its real estate and stock market bubbles burst in the 90s - failed to revive an economy in steep decline.

So far, negative interest rates haven’t done much to improve Japanese economic performance, and the picture is still one of sluggish growth. In fact, some commentators have pointed to the situation in Japan as evidence that the strategy is misguided.

Can home loan rates go negative?

It's not unheard of. In 2019, Jyske Bank, one of Denmark's largest banks, began offering mortgages with interest rates of -0.5% p.a. Simply put, borrowers would make repayments as usual, but their outstanding balance would be decreased by slightly more than is paid off at each instalment.

By the time their mortgage has been paid off in full, borrowers will have contributed less than what the bank originally loaned them. While this means customers are essentially getting paid to borrow, it's not necessarily coming out of the bank's pocket.

Rates in Danish money markets are well below zero at the moment, so if a commercial bank is able to price its home loans at a higher rate than what it's charged on loans from the central bank, then there's still a profit to be made.

Will Australia ever go down that path?

While the RBA has shown a clear bias against negative interest rates, we can’t rule it out as a possibility. After all, it wasn’t that long ago that the RBA denied quantitative easing was on the agenda and that program is currently well underway.

Whether or not we’ll go down that path depends a great deal on conditions overseas, especially in the US. That’s because decisions made by the US Federal Reserve tend to have knock-on effects on the Australian dollar.

Generally speaking, when interest rates fall in the US, the Aussie dollar rises as global investors scramble to park their money in Australian accounts (which all of a sudden become much more attractive).

A strong dollar isn’t always good news. It means that Australian exports become much more expensive in foreign markets, giving overseas buyers incentive to import from other countries with a lower exchange rate.

So if other central banks around the world continue to cut their interest rates, the RBA could face pressure to do the same, largely to offset these effects.

For more information about the cash rate and how it affects households’ finances, visit our home loan statistics page, where we provide a historical overview of the home loan market in Australia.

Home loan comparisons on Mozo - rates updated daily

Search promoted home loans below or do a full Mozo database search. Advertiser disclosure.
  • placeholder
    Mozo Experts Choice 2021
    Smart Booster Home Loan

    1 Year Discounted Variable Rate, Owner Occupier, Principal & Interest, <80% LVR

    interest rate
    comparison rate
    1.99% p.a.variable for 12 months and then 2.48% p.a. variable
    2.47% p.a.

    A super low introductory rate home loan with no monthly or ongoing fees. Unlimited free redraws and unlimited additional repayments to help you build your equity and own your home sooner. Multiple loan splits available. (Rates revert after introductory period ends). 20% minimum deposit required. Winner of two Mozo Expert's Choice Award for 2021.

    Go to site
  • placeholder

    Owner Occupier, Principal & Interest

    interest rate
    comparison rate
    1.75% p.a.
    fixed 3 years
    2.22% p.a.

    $0 fees and easy application. Choose between weekly, fortnightly or monthly repayments. 3 year fixed rates are for new Owner Occupier Principal & Interest loans.

    Go to site
  • placeholder
    Basic Home Loan

    Fixed, Owner Occupier, Principal & Interest, LVR<70%

    interest rate
    comparison rate
    2.09% p.a.
    fixed 3 years
    2.43% p.a.

    Get a flexible loan structure with up to six loan accounts with different rate types. Make free extra repayments. Enjoy free redraw facility. No upfront or ongoing fees. Option to earn Qantas points.

    Go to site
  • placeholder
    Mozo Experts Choice 2021
    Celebrate Variable Home Loan

    <60% LVR, Owner Occupier, Principal & Interest

    interest rate
    comparison rate
    2.19% p.a. variable
    2.19% p.a.

    Fast and efficient online application. Automatic discounts as loan is paid off. Free extra repayments and redraw facility. Zero fees to consider. Min 40% deposit required. Winner of three Mozo Expert's Choice Award for 2021.

    Go to site
  • Hot Deal$3,000 cashback when you refinance with Virgin Money (T&Cs apply)
    Special Offer Reward Me Fixed Rate Home Loan

    Owner Occupier, LVR <80%, 300k+

    interest rate
    comparison rate
    1.94% p.a.
    fixed 2 years
    2.77% p.a.

    Enjoy $3,000 cashback when you refinance with Virgin Money (T&Cs apply). Additional repayments up to $10,000 per annum. Reverts to the discounted variable rate on expiry of the fixed term.

    Go to site

*WARNING: This comparison rate applies only to the example or examples given. Different amounts and terms will result in different comparison rates. Costs such as redraw fees or early repayment fees, and cost savings such as fee waivers, are not included in the comparison rate but may influence the cost of the loan. The comparison rate displayed is for a secured loan with monthly principal and interest repayments for $150,000 over 25 years.

**Initial monthly repayment figures are estimates only, based on the advertised rate, loan amount and term entered. Rates, fees and charges and therefore the total cost of the loan may vary depending on your loan amount, loan term, and credit history. Actual repayments will depend on your individual circumstances and interest rate changes.

^See information about the Mozo Experts Choice Home Loans Awards

Mozo provides general product information. We don't consider your personal objectives, financial situation or needs and we aren't recommending any specific product to you. You should make your own decision after reading the PDS or offer documentation, or seeking independent advice.

While we pride ourselves on covering a wide range of products, we don't cover every product in the market. If you decide to apply for a product through our website, you will be dealing directly with the provider of that product and not with Mozo.