When debt is worth it: Negative real interest rates on loans

The rapid rise in inflation is causing the real interest rate for installment loans to tumble into the negative. How consumers can benefit from it – and what it all means for savers.

Getting money for borrowing money – that currently works with installment loans. Because the recent surge in inflation leads, according to the comparison portal Verivox, to a “historical exception”: According to this, the average interest rate of all installment loans concluded via the portal in July was well below the inflation rate.

Raise the curtain on the real interest rate

This puts an economic indicator in the spotlight that otherwise tends to eke out a shadowy existence: the real interest rate. The real interest rate is an important factor in calculating interest rates, but it is often underestimated by many consumers and savers. It results in the simplified form as follows:

The nominal interest rate is the interest rate agreed with the bank for a loan or the interest rate shown by banks for investments such as overnight or fixed-term deposits.

According to the Verivox evaluation, the median interest rate for installment loans in July was 2.99 percent. With an inflation rate of 3.8 percent last month, this results in a real interest rate of minus 0.8 percent. In other words, when you factor in the loss of purchasing power to debt due to inflation, borrowers have to repay less than they received. So you make money by getting into debt.

Rising interest rates – not in sight

But is the negative real interest rate for installment loans a sustainable trend or just a snapshot? In any case, one point of the calculation is relatively undisputed among economists: According to the market consensus, the European Central Bank (ECB) is likely to keep the key interest rate at the record low of zero percent for a very long time. Central bankers are too afraid of reacting too early and thus suddenly stifling the recovering economy.

Oliver Maier, managing director of Verivox Finanzvergleich, expects that July will not have been the last month with negative real interest rates. “Because the interest rates for installment loans will remain very low and in the course of the next few months the trend of rising inflation rates could even intensify.”

Inflation rate becomes a crucial question

However, it is precisely at this second point in real interest calculations, the level of the future inflation rate, that experts differ. Quite a few economists assume that the soaring inflation rates are a phenomenon that is limited in time.

The central bankers around ECB boss Christine Lagarde adhere to this reading. After the most recent ECB meeting in July, Lagarde stated that the inflation rate was “temporarily moderately above the target value” of two percent.

VAT reduction as a special factor

The currently high inflation rates are also being driven by the consequences of the temporary VAT cut: In order to boost consumption in the Corona crisis, the federal government lowered VAT from July 1 to December 31, 2020. Since then, the old tax rates have been in effect again.

If you compare today’s consumer prices with those of that time, they are significantly higher due to the VAT reduction in the previous year. However, this effect will expire at the end of 2021.

Greater risk with longer terms

In addition, pandemic-related production bottlenecks, for example due to disrupted supply chains, are currently causing prices to rise. These are also likely to be of a temporary nature. The big question remains what role does increased demand play in rising inflation rates. Because it could possibly be far less ephemeral.

The bottom line for consumers is that the sustainability of rising inflation rates has to be provided with at least a few big question marks. Consumers should take this into account when choosing their loans and especially the term. Because if the inflation rate falls over the term of the loan, the real interest rate should quickly jump back into positive territory. This increases the risk, especially with loans with longer terms.

Advantage for home builders

Incidentally, this also applies to home loans, which, however, have significantly lower interest rates: According to FMH-Finanzberatung, the average interest rate of 40 selected institutions for a ten-year mortgage was most recently 0.77 percent.

The inflation rate would have to fall below this value so that it is no longer worth going into debt for building or buying a house. For the next year, the ECB predicts inflation of 1.5 percent.

New record low for savings

Last but not least, consumers should note that there are currently negative real interest rates not only for installment loans and construction loans, but also for many financial investments that are particularly popular in Germany: call and fixed-term accounts.

Saving always costs more instead of generating a return – this is also shown by an analysis of the current data from the ECB by the provider Weltsparen. Accordingly, the average interest rate for private customers for savings of up to one year in Germany has fallen to a new record low of minus 0.04 percent. The average interest rate of the top 3 banks is zero percent. The average interest rate of the best three offers is 0.5 percent.

Stocks and real estate as a way out

In order to get the real interest rate, the inflation rate of 3.8 percent has to be deducted from these nominal interest rates. In Germany, consumers have to pay 3.3 percent real negative interest for savings of up to one year in the best case.

This sample calculation illustrates the dire consequences for the assets of the individual saver: After an investment period of one year, only 96,700 euros remain in real terms after an investment period of one year.

As a way out of the negative interest rate trap, savers who want to increase their wealth are ultimately the way to the stock or real estate market. Higher returns are possible there, especially with long investment periods, which more than make up for the currently rising inflation rates.