Why home loan interest rates are low are because Central Banks around the world have conducted an economic experiment. They have lowered interest rates to unprecedented low levels not seen before in many countries. And not seen in first world (OECD) nations since World War II in the 1940s.
Why would they do this?
Since the GFC (global financial crisis) in 2008/9, central banks around the world lowered official reserve bank interest rates in order to stimulate the economy and prevent an economic recession.
Central Banks Lower the Official Interest Rate
The lower rates make borrowing money less expensive and is designed to encourage people to borrow money for business, property and consumer goods. Central bank economists tell us that it is better to have low interest rates rather than run the risk of an economic activity slowdown or a recession.
When Central Banks lower the official interest rate this results in lower interest rates for borrowers at retail banks. Home loan interest rates decrease on all existing variable rate home loans and new home loans have a lower interest rate.
This is great news for people who finance their lifestyle with debt.
Lower rates result in home owners paying less interest on their home loans and having excess income available to spend or save. Also, home owners can borrow more money against their home and fund a more extravagant lifestyle. Now that boat, camper, new furniture or overseas holiday is easily within reach.
First home buyers can now afford to buy a home.
All home buyers are able to borrow more money and purchase more expensive homes.
Renters maybe able to afford to purchase their own home and build their capital rather than expense their earnings on rent.
So lower interest rates seem to be very appealing. Everybody can afford to have more!
Politicians Like Low Home Loan Rates
Governments around the world have been successful at convincing people to vote them into office because they have lowered or kept low interest rates. Voters seem to be brainwashed that low interest rates are good for them!
However, in 2019, ten years after the GFC most of those first world (OECD) countries still had record low interest rates. In fact, the interest rates were at “emergency levels”. Many countries have an interest of 0.5% to 1.5% while some countries even have negative interest rates which means the bank charges you a fee to deposit money into a bank account.
Why Home Loan Interest Rates Are Kept Low?
There wasn’t a recession in 2019. Most first world (OECD) countries had reasonable rates of GDP growth. The central banks should have increased interest rates back to normal levels.
When the Covid-19 pandemic hit in 2020, central banks lowered interest rates to virtually zero to prevent a worldwide recession. As the official interest rates were already very low the central banks could not lower interest rates much more before hitting zero.
However, did the very low interest rates prevent recession?
Home Loan Interest Rates Are Low During the Pandemic
During the pandemic lockdowns people could not go to work. Businesses were forced to reduce their level of activity (or close completely) and reduce their workforce. How would lower interest rates help businesses that could not operate? Would low interest rates really help people with no job?
Why Low Interest Rates Are Not Popular
Very low interest rates caused cash and fixed interest investors to make considerably less income. Many older people who are retired or semi-retired rely on earning interest on their life savings. These people were unnecessarily punished with low interest rates and the large reduction in their investment income. How would investors afford to live?
The actual result was the lowering of interest rates caused a property boom. Home buyers could afford to borrow more money and pay higher prices for homes. Home owners took the opportunity to upgrade to a better home. Many people moved from large cities to regional areas where property prices were lower and to avoid covid-19 lockdowns. Many older investors bought property because they couldn’t earn enough interest on fixed interest investments.
However, there is an even worse result from lowering interest rates.
Inflation!
A low interest rate makes money cheap. People borrow more and spend more money.
And anyone who studied Economics 101 knows that the increased demand over supply causes prices to rise. In other words, inflation.
Now, Central Banks are scrambling to raise interest rates back to normal levels to curb inflation.