Don't just end it with 'Variable interest rates are scary.' A 40-something office worker's take on 'Mortgage x Index Investing'

I’ll state this upfront.

I myself do not have a variable interest rate.

Ten years ago, I took out a mortgage with a fixed rate for the entire term.

So, this article is not a personal account from someone who chose a variable rate.

It is an organization of my thoughts based on the premise of ‘If I were to borrow now.’

A mortgage is a debt.

That’s why I thought it should be paid off as quickly as possible.

However, now that I have been investing for five years, I have a slightly different perspective.

Why can’t I, as someone who borrowed at a fixed rate, ignore the concept of ‘Variable Interest Rate x Index Investing’?

I will write about it in order.

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Don’t think of mortgages and investments ‘separately’

When it comes to mortgages, the conversation tends to go like this:

‘Fixed rates are safe’

‘Variable rates are scary because interest rates might rise’

‘It’s better to pay off debt as soon as possible’

Of course, none of these are wrong.

However, I have recently started to think,

‘Is it really necessary to judge based only on the mortgage?’

Household finances include not just loans, but also:

・Cash

・Savings

・Investment trusts
・Housing
・Insurance
・Monthly income
If that’s the case, it’s fine to think of the mortgage as ‘part of the overall household finances’.
That is how I think about it.

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With a 40 million yen mortgage, the monthly difference is significant

For example, suppose you borrow 40 million yen over 35 years.

This is just a calculation to explain the concept, but if we assume a variable rate of 1.1% per year and a fixed rate of 3.4% per year,

Variable rate: approx. 115,000 yen/month

Fixed rate: approx. 163,000 yen/month

The difference is about 48,000 yen.

That’s about 580,000 yen per year.

This difference is quite large.

Of course, variable rates carry the risk of interest rate hikes.

Therefore, I do not intend to simply think,

‘Variable rates are cheaper, so they are a better deal.’

What I am thinking about is,

‘If you choose a variable rate, how do you handle that difference?’

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Don’t spend the ‘extra money’

This is the most important part of this way of thinking.

You chose a variable rate and your monthly repayment amount went down.

Don’t just end it with,

‘I saved 50,000 yen a month. Life has become easier.’

If it were me, I would treat some or all of that as ‘money that doesn’t exist’ from the start.

And then, I would put it into index fund accumulation.

For example,

I would set 2.5%, the upper limit of the Bank of Japan’s neutral interest rate estimation range, as a stress scenario.

I would invest the difference from the assumed repayment burden at that rate from the beginning.

Of course, there is no guarantee that 2.5% will be the upper limit for future interest rates.

I use this not as a prediction, but as a figure to confirm,

‘Can the household budget withstand it if rates rise that much?’

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Don’t just ‘use and be done with’ the mortgage tax deduction either

Another thing to consider is the mortgage tax deduction.

The mortgage tax deduction is a system where, if certain requirements are met, a deduction is made from income tax based on the year-end mortgage balance, etc. (National Tax Agency)

Instead of using the money that comes back here by thinking,

‘It’s extra income!’

I would put it into investments.

In other words,

1. The interest rate difference on the mortgage

and

2. The tax burden reduction from the mortgage tax deduction

are directed toward asset building.

By doing this, you can grow your financial assets while still carrying a mortgage.

However, the eligibility and deduction amount for the mortgage tax deduction vary depending on the year of move-in and housing performance.

It is not a story that ‘you will always profit if you take out a mortgage’.

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How to use investment assets if interest rates rise

This is the core of this way of thinking.

Suppose that in the future, mortgage interest rates rise significantly.

At that time, instead of ending it with,

‘I knew variable rates were scary,’

I would look at the entire household budget, including the investment assets I have built up until then.

If necessary, there are options such as:

・Temporarily reducing the investment amount

・Using cash
・Making a partial early repayment
・Considering refinancing the loan
In other words,

Don’t fight against interest rate hikes with just the mortgage.

Keep some ‘defensive power’ on the asset side as well.

This is my take on ‘Variable Interest Rate x Index Investing’.

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However, there is a big pitfall here

This method is not for everyone.

Since I have a fixed rate, I haven’t experienced the true fear of rising interest rates.

I am writing this from a safe position, but I think this is actually the most important point.

You must pay your mortgage every month without fail.

On the other hand, the valuation of index investments changes every day.

The stock market can drop by 30%.

In some cases, it can drop even more.

At such times, if you find yourself in a situation where,

‘I still have tens of millions of yen left on my mortgage’

‘My investment assets have dropped significantly’

‘My bonus has also decreased’

it would be mentally very tough.

Moreover, variable rates have another risk: interest rate hikes.

Even in a survey by the Japan Housing Finance Agency, a certain number of variable-rate mortgage users answered that they are ‘a little anxious about whether they understand’ or ‘do not understand well’ the rules for reviewing applicable interest rates and repayment amounts when interest rates rise. (Japanese Bankers Association)

That is why I believe that

‘Variable rate x investment’ should not be judged solely by the interest rate difference.

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It’s not ‘okay because there’s a 5-year rule and a 125% rule’

There are products with so-called ‘5-year rules’ and ‘125% rules’ set for variable-rate mortgages.

However, this is not a mechanism common to all mortgages. (Japanese Bankers Association)

And the fact that the repayment amount does not increase immediately and the fact that you are not affected by interest rate hikes are completely different stories.

Even while the repayment amount is fixed, if the proportion of interest increases, the reduction of the principal will slow down.

In some cases, there is also a possibility that unpaid interest will occur. (Japanese Bankers Association)

That is precisely why,

instead of thinking ‘it’s okay because it will only go up to 125%’,

you need to check what will happen when interest rates rise under your own contract.

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Don’t think of ‘debt’ and ‘investment’ separately

I don’t want to recommend actively using a mortgage as debt for investment.

For many people, a mortgage will be the largest debt of their lives.

That is why you should be cautious.

However, I also think it’s a bit wrong to divide things into black and white,

saying ‘it’s bad because it’s debt’ or ‘it’s justice because it’s investment’.

What I am thinking about is looking at the liability of a mortgage and the asset of index investment as a whole household budget.

That is all.

If you choose a variable rate, build up cash and investment assets in preparation for interest rate hikes.

If you choose a fixed rate, find value in the stability of the repayment amount.

Both have merits and risks.

What is important is not ‘which one is the correct answer’,

but rather thinking about ‘can my household budget withstand it even if interest rates rise or stock prices fall?’

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My current position after choosing a fixed rate

Currently, my investment assets have exceeded my remaining loan balance.

I have only made an early repayment once.

That was because I wanted to finish the mortgage by the age of 60.

However, the low 1% fixed rate from 10 years ago is a condition that can no longer be replicated for people today.

I don’t think I profited because my judgment was wise, but because the timing was good.

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Conclusion

Since I started investing, I have come to view my entire household budget as a single portfolio, rather than thinking of “loans as debt” and “investments as assets” separately. No one knows what future interest rates or stock prices will be. That is precisely why I want to think about “creating a household budget that is resilient no matter what happens” rather than “trying to predict the future.” Do you view a mortgage as “a debt that should be paid off quickly”? Or do you see it as “part of a household budget where assets and liabilities are managed as a set”? What do you think?

Thank you for reading until the end. My past articles are summarized here.

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