Negative Interest Rates in Canada?


What are Negative Interest Rates?

As almost everyone who cares about them knows, interest rates are the price a borrower pays to a lender to borrow money. In the case of a mortgage, you borrow a certain amount to buy a home and every year, you will pay a little bit more for the ability to borrow the money in the first place.

These days, thanks to some European banks who are desperate to get their economy off the floor, there is talk of "negative interest rates." Presumably, that would mean, if you borrow $100,000 at -2% to buy a condo, the borrower would owe you $2,000 after the first year, which would presumably be applied to the principle, which means you would owe less. If that sounds very strange and even experimental, you are not alone. Up until 2014, no one had ever done that before, and most are not likely to ever start to do so soon.

The Need for Economic Stimulus 

When you think about it, you can see why negative interest rates might seem like a great incentive to borrow money, but the reality is, it's difficult to comprehend why a lender would be willing to pay someone to borrow money from them, especially given that it is the lender who is taking on the risk of default on the loan.  

When the economy starts to falter, people, banks and other businesses tend to hold on to whatever cash they have while they wait out the hard times. Unfortunately, when they do this, the lack of spending results in a lack of economic activity, including job losses and reduced profits. Therefore, central banks have to find ways to get money circulating through the economy again. Many experts believe that a few European central banks have simply run out of available options when it comes to stimulating the economy and preventing deflation, so some have become desperate.  

Will Negative Mortgage Rates Come to Canada? 

Recently, the head of the Bank of Canada, which is Canada's central bank, suggested that the country could potentially join them should there be another global financial crisis like the one that occurred in 2008, most Canadian economic experts are doubtful that such a thing would happen and, if it did, it would be very short term and it may not have any impact on interest rates.  

A negative interest rate would provide a lot of encouragement to people to spend and invest money rather than hoard it. Such a thing would also make Canadian goods more cost-competitive in the global market. However, while mortgages might go down somewhat, and in some countries, like Denmark have seen some mortgage rates go below zero, banks in Canada would be more likely to simply sit on their cash and wait out the hard times. Profit-making companies can't justify losing money by lending out huge sums of money to people for a home. That means the overall effect might be the opposite of what is hoped by implementing negative interest rates.  

The Bank of Canada is unlikely to ever establish a negative prime rate. They have a number of other tools available to it that some European banks don't have available to them. For example, the Canadian government seems more than willing and able to apply targeted fiscal stimulus measure to specific economic areas that need it.  

Put simply, while a few countries have tried this strange and new tactic to stimulate their economies, don't expect Canada to follow suit. They promised to keep it around as a possibility, but that's all. And even if they do use it, no one should expect to have a negative mortgage rate; lenders are likely to just hold onto their money and not lend it for mortgages, rather than pay a premium.

Morgan Pavia - James Mortgage Exchange

4/26/16 4:16 pm News