September 2019 Newsletter
Would you like to receive interest when taking out a mortgage?
Dear Clients and Friends,
Would you like to get paid for borrowing money? Does this sound crazy?
Those of us who went through the 1990 mortgage rates of 17% a year are still getting used to seeing mortgage loan rates that start with a 3, i.e. interest rates under 4%, let alone the latest fixed interest rates that start with a 2!
However, in Denmark, fixed mortgage rates are going negative. If you fix your interest rate for 3 years, the bank will pay you in some cases 0.28% interest and if you fix for five years, you can still receive 0.04%. That is before bank fees but is still quite something to get your head around – getting paid for borrowing!
In the past in Australia and in many other countries, mortgage interest rates were similar to the 10-year government bond rate – the rate at which the Australian government can borrow.
In Denmark this 10-year bond rate is -0.66%, i.e. the government gets paid to borrow money. The Danish government still has to pay back the principal, but that principal is reduced by the negative interest rate.
In Australia, 10-year bond rates have dropped from 5%+ to under 1% in the last 10 years. It wouldn’t take much of a step for those rates to go negative and eventually, our mortgage market may see interest rates that start with a low 2, a 1 or even less than 1% as is already happening in Denmark and other countries.
I have no idea whether this will actually happen but at the moment it is quite possible that low interest rates will be around for quite a while and even countries like Australia, which is quite small and growing in population, seem to be able to access borrowed money at very low rates.
Why are there such things as negative interest rates?
It makes no sense, couldn’t people just keep money in cash? The answer is, “no, they can’t”. Cash is very expensive to handle and secure. There are lots of organisations like pension funds or insurance companies or even businesses that know they have to pay out, for example, a hundred million dollars in 10 years’ time and can’t or aren’t allowed to pay it any earlier. Where will they put the hundred million dollars in the meantime?
If they buy Australian government bonds, they will get about 1% interest for those 10 years. Other governments, Brazil for example, pay substantially higher interest rates of over 7% but then you have a currency risk and a default risk – some governments can have difficulties paying money back in the future. In other words, if you want to be almost absolutely sure to get your money back in Australian dollars when you want that money, then an Australian government bond is for many people the only choice.
In Europe the situation is even more pronounced – if you want to lend your money to a safe borrower like Germany, you have to pay them.
All of this is very good for borrowers, but for investors it is getting more and more difficult to find a place where you get a decent interest rate. There are ways to deal with this but they depend on the circumstances of each individual investor.
The Financial Times recently had an article by a journalist called Robin Harding “Profoundly low interest rates are here to stay” and a reader who goes by the pseudonym Occam wrote the following comment that I found very interesting:
“Zero interest rates are an essential characteristic of a large, mature economy. Nothing can grow exponentially indefinitely nor can a large economy continue growing at 3%. Everything is already there, the need for capital is very limited.
At the same time the supply of capital is super abundant after decades of growth and capital accumulation. So the cost of capital trends towards zero. During the Middle Ages real interest rates were at or near zero for more than 300 years.
The subsequent industrial revolutions accelerated growth and explosives got more powerful ensuring capital goods got blown up on a regular basis. An unusual period of relative capital scarcity and positive real interest rates. We are going back to the old normal, which is the normal normal, really.
The last 2 centuries were an aberration, especially the decades after WW II, when the whole world got blown up, leading to interest rates that were structurally elevated. That was an abnormal normal, which felt like the normal normal. But the only reason it felt that way is because the human lifespan is so short compared to these cycles."
During the Middle Ages, we had massive inflation or deflation (prices dropping) in any given year because harvests were good or bad due to the weather or war, but overall prices didn’t move. I found Occam’s reasoning very interesting.
Especially in this low interest environment, if you know somebody who would like a second opinion on their financial arrangements, could you give them my contact details? That could be very helpful for them as the first meeting is free and with many advisers retiring at the moment it may be hard to find good financial advice.
As always, feel free to contact me at any time if you have any questions or wish to discuss this or any other matter.
AFP LRS Adv. Dip.FS (FP) EPA Acc. MBiostats
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