Negative Interest Rates: Someday The Bank May Pay You For Your Mortgage!

Cue a familiar record: Canada has an epic housing bubble. Analysts at Bloomberg News recently put together a new index of housing bubble risk and found that New Zealand and Canada are the developed world’s champions.

Yet we’ve been hearing this for years, haven’t we? Experts have been warning of a Canadian housing bubble for nearly a decade at this point. These calls have become like the Boy Who Cried Wolf. Nobody listens anymore. Which is a shame, if you consider how the story of the boy who cried wolf actually ended.

There is a hard limit on any housing market, and that is the maximum amount a homebuyer can borrow for a mortgage. The lower the interest rate, the higher the house price you can carry for the same monthly payment.

In Canada, interest rates have been on a broad downward trend for decades.

The result? House prices have been rising faster than incomes for decades. The financial blog Wolf Street illustrated this recently in a blog on “Canada’s most splendid housing bubbles.”

Using data from the Teranet-National Bank house price index, Wolf Street found that house prices more than quadrupled in 16 years in Vancouver, and more than tripled in Toronto in that time. 

It’s not a coincidence that the upward line of house prices is the opposite of the downward line of interest rates. And now the conventional wisdom is that, with interest rates near zero, this long-running trend has to come to an end.

The machine that has been pushing up house prices for decades ― that has made Canadians accustomed to the idea that “house prices always go up” ― is out of juice. 

But is it really? Faced with signs of a global economic slowdown, central banks are once again juicing the global financial system by lowering interest rates and buying debt. The U.S. Federal Reserve is widely expected to cut its overnight lending rate this Wednesday, the first time since the financial crisis that the Fed has cut rates.

In many countries, key lending rates and interest on government debt (the safest kind of debt) are now below zero. There is a record amount of debt with negative interest rates on it in the world today.

But it’s unlikely those negative rates will ever mean negative mortgage rates, right? Will a bank ever pay you to take a mortgage? 

Well, actually, it has happened: In some of the northern European countries with negative interest rates, some people with variable-rate mortgages have found themselves being paid for their mortgage, instead of paying interest to the lender.

And ― perhaps insanely, perhaps in a sign that our whole financial system is on the brink of technocratic madness ― this could actually become policy.

Making a profit from negative rates

Canada’s economy has become so dependent on the housing market that it’s not hard to imagine a scenario where, in an economic downturn, the Bank of Canada props up house prices by following other central banks into negative territory and setting its key rate at, let’s say, minus-1 per cent. 

For every $100 it lends, it pays the borrower $1 for borrowing the money. After a year, the borrower has $101. 

Now let’s say the BoC lends this money to a commercial bank, which lends it out in the form of a mortgage at minus-0.5 per cent. It pays the mortgage borrower 50 cents for every $100 they borrow, but it gets $1 from the BoC for that same money. Thus the bank turns a profit of 50 cents by lending that money at a negative interest rate.

In a competitive mortgage market, if a bank can make money offering a negative interest rate to borrowers, it will. And bingo ― here’s your model for juicing the economy right into bizarro world.

Make life easier, borrow more

Would this drive up debt levels? You bet. But in this environment, you could pay off your debt more easily … by taking on more debt. 

Say you have $100 of debt and you’re paying 5 per cent on it, or $5 per year. You borrow another $100, this time at minus-1 per cent, and make $1 for carrying that debt. That reduces the cost of the first $100 you borrowed to $4.

While it may seem crazy for a bank to pay you to borrow money, the central banks may see themselves as having no alternative ― it’s either that or let the debt-laden economy crash without intervention. And for mortgage lenders, a profit margin is a profit margin, however you make it.

So there you have it. A future in which banks make money by paying you to take a mortgage, and where you can make your debt easier to handle by taking on more of it. (And in which central banks are constantly printing more money.)

Is this the solution to the inevitable long-term slowdown in Canada’s housing market? Or is this monetary madness of the highest order?

If central banks keep doubling down on their low-rate strategy, we may find out one way or the other, soon enough.