[Home Loan 2] Is choosing only a “variable interest rate” for economic rationality dangerous? Risks you should know and the wall of debt-to-income ratio

When taking out a home loan, many people compare and consider various products.

“I just want to keep my monthly payments down, so a variable interest rate is the only choice!”

Many people think this way, and if you look only at the immediate payment amount, it certainly seems to make economic sense. However, “Are you sure it’s okay to decide based on that alone?”

In this article, I will explain in an easy-to-understand manner the disadvantages of variable interest rates that are often overlooked, and the “debt-to-income ratio,” which is a major hurdle in home loan screening.

1. Why variable interest rates are starting to rise right now

While ultra-low interest rates have continued until now, with the Bank of Japan’s policy interest rate hikes, variable interest rate products from major banks and online banks are already on an upward trend.

When the policy interest rate rises, the “short-term prime rate” that banks use as a benchmark rises, and there are increasing cases where home loan interest rates are also linked and increased by about 0.25% to 0.5%.

Some banks are thought to be “raising interest rates in advance in anticipation of the next interest rate hike.” This is because they are taking a defensive stance in consideration of risk management and public perception, rather than revising rates after the fact every time interest rates rise.

What you should be careful about here is the “5-year rule” and the “125% rule” unique to variable interest rates.

2. The scary mechanism of the “5-year rule” you should know

The “5-year rule” is a consumer protection mechanism that says even if interest rates rise, the monthly repayment amount (the face value) will not change for 5 years.

You might tend to think, “Then I’m safe for 5 years!” but in reality, only the “total payment amount” remains unchanged, while the “breakdown” changes significantly.

Let’s explain with a concrete example (*this is a simplified example for clarity)

Let’s look at the breakdown when paying 150,000 yen per month.

In this way, you fall into a state where “you are paying the same amount every month, but the principal is not decreasing at all.” If the principal does not decrease, high interest will continue to be charged on the principal from the following month onwards, so the future burden will become heavier and heavier.

*Recently, some loan products have emerged that “deliberately do not apply the 5-year rule” in consideration of the current interest rate hike phase. In that case, if interest rates rise, the monthly payment amount will increase immediately, so you need to be careful either way.

3. The “125% rule” does not exempt you from payment

The other “125% rule” is an upper limit rule that states that when 5 years have passed and the monthly payment amount is reviewed, “it must not be increased by more than 1.25 times (125%) of the previous payment amount.”

For example, if you were paying 100,000 yen per month, no matter how much interest rates skyrocket, your payment amount for the next five years will be capped at a maximum of 125,000 yen.

At first glance, this looks like a lenient rule, but the interest burden that exceeds this amount does not simply disappear.

The interest burden that could not be covered will either be added little by little to future monthly payments or will have to be paid in a lump sum at the final payment. You must interpret this rule correctly so as not to mistake it for a “reduction or exemption system.”

4. The “debt-to-income ratio” barrier standing in the way of home purchases

On the other hand, while “fixed interest rates” offer the peace of mind of a locked-in rate, the set interest rate is higher than that of variable rates, and monthly payments tend to swell. This is where the “debt-to-income ratio” becomes a barrier.

What is the debt-to-income ratio?

It is “the percentage of your annual income (gross) that goes toward annual loan repayments.”

• Standards such as Flat 35: Within 30% to 35%

• Standards for major banks and variable interest rates: Although not publicly disclosed, there are cases where they approve screenings for as high as 40% to 50% in practice.

For example, if a person with a gross annual income of 3 million yen buys a home using Flat 35, the allowable annual loan repayment amount is “up to approximately 1 million yen (about 85,000 yen per month).”

With construction costs and property prices soaring as they are now, more people are hitting this debt-to-income ratio limit and are unable to borrow the amount they desire.

Car loans and revolving payments are also included!

The calculation of the debt-to-income ratio includes not only the mortgage but also the total repayment amounts for car loans, residual value setting loans, revolving payments, and card loans.

If you have a high-cost car loan remaining, that alone will significantly reduce the amount you can borrow for a mortgage. When considering a mortgage, it is essential to first accurately grasp “how much you are currently paying in loans and revolving payments each month.”

5. Unreasonable loans can ruin your life! What is appropriate risk management?

In the past, when housing prices were low, it was somewhat affordable even if your annual income wasn’t high. However, in the current era where “soaring property prices” and “rising interest rates” are happening simultaneously, it is a dangerous time to jump in carelessly, even for those who could have bought before.

If you borrow to the absolute limit just because the loan has loose screening criteria (allowing for a high debt-to-income ratio), your repayments will collapse the moment interest rates rise, and in the worst case, it will lead to a home auction or personal bankruptcy.

As for sound risk management, I strongly recommend “keeping your actual debt-to-income ratio to around 15% to 20% when taking out a loan.”

Summary: Use it “planfully” after understanding the disadvantages!

• Variable interest rate: Payments are cheaper in the short term, but there is a risk that the principal will be harder to reduce when interest rates rise and that you will be billed for a lump sum in the future

• Fixed interest rate: Payments are secure, but the initial interest rate is high, making the debt-to-income ratio screening stricter

It is most important to choose only after fully understanding the disadvantages and future risks rather than being captivated only by the benefits.

A home is the biggest purchase in your life. Truly, ‘use it wisely.’ Take sufficient risk countermeasures and let’s build a repayment plan with plenty of room!