The Bank of Japan has lifted negative interest rates. What should people who are planning to buy a home or who have already taken out a mortgage be careful about?

In general “lower interest rates, larger amounts, longer terms.”

The Bank of Japan has raised interest rates for the first time in 17 years. Those who are about to buy a home or those who have already taken out a mortgage to purchase a home are concerned about the future trend of interest rates. Those who are sensitive to interest rates are those who are highly informed. This is because a 1% increase in interest rates will increase mortgage payments by about 18%. This is such a large change in repayment amount due to interest rates. The monthly repayment amount is determined by the combination of the property price and the interest rate. We may suffer the double whammy of higher property prices and higher interest rates in the future, but we should have a better strategy to deal with it.

I am in a position to give you pointers on how to take out a mortgage. Loans are of paramount importance in the purchase of real estate. The way things have been explained: “Keep the interest rate low, the amount high, and the term long.” The idea is to choose a low variable interest rate, and if possible, borrow the entire amount as a loan with as little down payment as possible, and with the longest term of 35 years. This has been basic rule of thumb.

The Bank of Japan’s policy has increased the likelihood of an increase in variable interest rates for mortgages. Prior to this, it had allowed long-term interest rates to rise from December 2022. This led to an increase in long-term fixed rates, and the interest rate gap between variable (about 0.4%) and fixed (about 1.9%) rates opened up to about 1.5%. With the gap so wide open, it was rare for anyone to choose a fixed rate. This is because there is a 28% difference in monthly repayments for the same loan amount.

The focus is on “what will happen to the difference between variable and fixed interest rates?”

The future focus for prospective buyers is said to be “will variable interest rates go up?” but that is not the case. If variable interest rates were to rise by 0.3%, would they stop buying a home?　People who acquire their own homes often have families, and the timing when they want a home is often before marriage or before their children enter elementary school. It is simply a matter of choosing the most advantageous loan at the timing they want it.

That is why the focus is on what the difference between variable and fixed interest rates will be. So let’s understand the characteristics of the two interest rates. In many cases, variable interest rates are determined based on the short-term prime rate, while fixed interest rates are determined based on the yield of 10-year government bonds. The difference between short-term and long-term interest rates differs by a factor of three or more for terms of one year or less. Although interest rates may rise, short-term interest rates do not rise as significantly as long-term interest rates. In addition, while this difference tends to narrow when interest rates are in a downtrend (in the past, the interest rate differential has narrowed to about 0.5%), it tends to widen when interest rates are in an uptrend. At present, the gap is 1.5%, and it is difficult to imagine that the gap will widen or even narrow when interest rates are on the rise.

It is likely that banks will continue to hold out on interest rates.

Let’s consider variable interest rates from the perspective of lending banks: variable interest rates, which are borrowed by more than 90% of borrowers, are the mainstay of mortgage products, and the only way to differentiate them is through interest rates. If they raise interest rates, they will simply lose customers to other banks. It would be almost suicidal for an online bank to make such a choice, especially when mortgages have such a large impact on their performance.

In their fierce competition for customers, the era of requiring a down payment has come to an end, and more than half of all borrowers are now taking out a full loan. Under these circumstances, interest rates are likely to remain patient, and I predict that even if they rise, it will be only 0.1-0.2%. It is no exaggeration to say that the benefit will be on the borrowers’ side.

That being the case, for the time being, choosing a fixed rate or refinancing from variable to fixed is not a realistic option.

Even though the decrease in principal has been slow, property prices have increased more than the decrease

Next, consider the risk of variable interest rates going up after you borrow. There are two rules you should know about. The 5-year rule means that the interest rate will be reviewed every six months or a year, but the repayment amount will not change for five years, while the 125% rule means that the repayment amount after the review cannot increase by more than 1.25 times the previous amount. With these two rules in place, you won’t find yourself in a situation where you have trouble repaying your home loan.

Even if the principal decrease slows down, there is nothing to worry about because property prices have risen more than that. This is because the land that condominium developers have already stocked up on is about 20% more expensive than the land that will be newly built in the next two years, so the market price is set to rise.

As interest rates rise, many Japanese consider loans to be a mental burden. If interest rates are going to rise, they may be tempted to pay off the loan early. In such a case, let’s consider the following logic.

Having extra funds in the mortgage is a “fallback plan.”

In the past, when interest rates were around 2%, the recommended course of actions was to have loans be paid off early. For example, here is what was said.

“Paying off your loan early is the same as investing in a no-risk financial instrument. If the interest rate is 2%, it is equivalent to having earned 2% interest for sure. In an era when savings accounts earn only a drop in the bucket, prepayment of a mortgage is an excellent financial instrument that earns a yield equivalent to the interest rate with absolutely no risk.”

However, situations have changed. There are an increasing number of cases where a large sum of money is needed for children’s higher education or to care for parents, etc. However, there are no loans other than mortgages that provide individuals with a large sum of money at a low interest rate. Having extra funds on hand with a mortgage loan may be a “fail-safe” measure, should the need arise. We now believe that it is not too late to pay off the mortgage early, once you have a large sum of money from retirement, inheritance, etc. and can anticipate expenses.

If you rush to prepay, you may lose money.

So there is little point in rushing to pay it back at a rate less than 1%. It would also be a loss to pay it back if the remaining balance is less than 40 million yen, since that would only reduce the 0.7% refundable mortgage deduction. If you are going to pay back the loan, it will be more correct to do so after at least 10 years, when the mortgage deduction will cease to apply.

In addition, there could be cases where real estate prices fall during a phase of rising interest rates. In this case, selling the property and paying off the mortgage would be a more effective option than refinancing. Selling would be one of the rational decisions, since the property holdings would diminish and the interest rate burden would increase. However, since the interest rate increase will not be large, the impact on real estate prices will be minimal. That being the case, I believe it is not too late to sell now that prices are rising and it is not too late to sell when real estate prices begin to fall.

The fact that the impact of interest rates is minimal means that it is better to rest easy and focus on other issues. When we are in a situation where we can expect interest rates to rise, there are often policies in place that will more than make up for it. It has been common in the past for tax breaks to be combined with sales tax increases on buildings in order to curb the rush. This time, the focus is mainly on tax breaks and subsidies for homes with good insulation performance, which are labeled “energy efficient.

Energy conservation” and “special gift exemptions” are the keys.

The first tax credit is the mortgage deduction, which is refundable from income and other taxes. The interest rate is compensated up to 0.7% under this tax credit program, so even if the current variable interest rate level rises, the borrower is better off with a negative loan-to-value ratio. In many cases, borrowing a mortgage would increase cash rather than paying interest.

In 2024, the eligible amount for new construction has been reduced to zero unless it complies with energy conservation standards. The amount for new construction is 30 million yen for compliance with energy conservation standards, 35 million yen for the ZEH level above that, and 45 million yen for superior long-term or low-carbon housing above that. The same applies to existing homes: 30 million yen for those that meet or exceed energy conservation standards, but 20 million yen for others. The difference of 10 million yen here is 70,000 yen per year, or 140,000 yen for a pair loan, which amounts to a cumulative 910,000-1,820,000 yen over 13 years for new construction, and 700,000 yen over 10 years for second hand housing. In other words, the maximum 45 million yen difference for new construction would result in a cumulative 4,095,000 yen difference in cash.

Second, the tax system currently allows for a special gift limit of ¥5 million for home acquisition. In the case of “high quality housing,” the amount will be increased by 5 million yen to 10 million yen. For example, if the house is rated at Insulation Performance Grade 4 or higher, the gift of ¥5 million is exempt from the gift tax of ¥850,000. In addition to this, there is an annual tax exemption of ¥1.1 million for calendar year gifts.

It is a good idea to choose an energy-efficient house when receiving a “gift” when purchasing a home.

Regarding this, let’s talk about a “gift of housing funds” in the context of talking about a variable interest rate increase, and if not, let’s talk about borrowing. If we can borrow, we should write on the IOU that the interest rate could be as low as 0.1%, since we are in this era of low interest rates. And let’s use the 1.1 million yen calendar year gift limit every year. In other words, even if you borrow 10 million yen and pay it back in 10 years, you can offset it against the calendar year gift and make it tax-free.

In order to combine these gifts, choose a property from “high quality housing” if it is newly built, and if it is second hand, insulate and renovate it before moving in. Up to 80% of the cost of this renovation will be returned in the form of a subsidy (depending on the region, eligible products, etc.), which may be recouped in reduced utility costs over several years. Since the renovation cost is also covered by the mortgage, it will also be possible to offset the brokerage fee payment with the returned subsidy. In addition to this, there is also the renovation promotion tax system, which provides a refund of 10% of the amount paid for renovation from income tax and a reduction of 1/3 of fixed asset tax.

Energy conservation “is a treasure trove of subsidies and tax breaks.”

There is also a subsidy called the Children’s Eco-Home Support Program. When purchasing a new custom-built house or a house for sale with high energy-saving performance (ZEH level), a subsidy of 1 million yen per unit is available for households with children or young couples. Some subsidies of up to 2 million yen are also available for the renovation of existing homes mentioned earlier.

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