Thinking About 'Choosing a Reasonable Mortgage' During a Period of Rising Interest Rates
Mortgage interest rates are starting to rise.
Therefore, this time, I will share three important points to keep in mind when taking out a mortgage from now on.
1. The three main types of mortgage interest rates
There are broadly three types of interest rates for mortgages. We will look at their characteristics and points to note.
1-1 Variable interest rate type
This is a type where the repayment interest rate fluctuates in line with the economy.
If the repayment interest rate does not rise during the repayment period, the total repayment amount will be lower than other types.
However, if the repayment interest rate rises, the monthly repayment amount will also increase. It is difficult to foresee future monthly repayment amounts, which could affect your household budget.
Note that the ‘5-year, 125% rule (described in 3-3 below)’ applies to the repayment amount when the variable interest rate rises, but some financial institutions do not apply this rule, so it is necessary to check before borrowing.
1-2 Fixed-rate period selection type
Depending on the financial institution, the repayment period can be 2, 3, 5, 7, 10, 15, or 20 years, and the repayment amount is fixed during the fixed period.
Also, the longer the fixed period, the higher the interest rate, and the shorter the period, the lower the interest rate.
Many financial institutions automatically switch to a variable interest rate after the fixed period ends, or allow you to re-select a ‘fixed-rate period selection type’ or ‘variable interest rate type’ based on the interest rate at that time.
For example, suppose you sign a mortgage contract for a 35-year repayment period and initially contract for a ’10-year fixed period.’ From the 11th year after borrowing, regardless of which interest rate type you choose, the repayment amount will be determined by the repayment interest rate at that time.
1-3 Full-term fixed interest rate type
Like Flat 35, this is a type where the repayment interest rate and repayment amount do not change even if market interest rates fluctuate during the repayment period.
While it is easy to plan your life during the repayment period and for retirement, the repayment interest rate is set higher than the variable interest rate type or the fixed-rate period selection type.
2. Mortgage deduction
The mortgage deduction is a system where, when you repay a loan for building, purchasing, or renovating your home, 0.7% of the year-end loan balance (remaining principal) is deducted from your income tax, etc., for a period ranging from 7 years to
a maximum of 13 years.
2-1 Mechanism of the system
If you meet the income, floor area, and location requirements, you can deduct 0.7% of your year-end loan balance from your income tax for 10 to 13 years, within the ‘borrowing limit,’ depending on the performance of the home, such as ‘Long-term Quality Housing,’ ‘Low-carbon Housing,’ or ‘ZEH-level Energy-efficient Housing.’
Any amount that cannot be fully deducted from income tax will be deducted from the following year’s resident tax. The deduction from resident tax is limited to 5% of taxable income, up to a maximum of 97,500 yen.
As a general rule, you must file a tax return for the first year. For company employees, you can handle the procedure through year-end tax adjustment from the second year onwards.
2-2 Homes to which this does not apply
The following homes are not eligible for the mortgage deduction: ・Homes that do not meet certain energy-efficiency standards ・Homes with a floor area of less than 50 square meters, or less than 40 square meters for homes meeting certain conditions ・Homes that you do not live in yourself, such as rentals or vacation homes ・Homes built under standards from 1981 or earlier that cannot prove earthquake resistance, etc.
Before purchasing a home, it is important to confirm with the real estate agent selling the property whether it is eligible for the mortgage deduction.
Homes eligible for the mortgage deduction may have a higher purchase price than those that are not. However, you may want to choose a home to purchase while considering the maintenance costs after moving in and the tax amount that will be deducted through the mortgage deduction.
3. Things to check before borrowing
Before signing a mortgage contract, it is a good idea to check the following.
3-1 The difference between gross and net salary
When a financial institution reviews a mortgage application, if the borrower is a salaried employee, they calculate based on the person’s gross salary. However, it is essential for the borrower to calculate based on their net income, which is the amount remaining after taxes and social insurance premiums are deducted from their salary.
The reason for this can be understood through the ‘repayment ratio’ below.
3-2 What is a ‘repayment ratio’?
The repayment ratio is a ratio that tells you what percentage of your annual salary goes toward mortgage repayments.
<Repayment ratio calculation formula>
Annual mortgage repayment amount / Annual income x 100 = Repayment ratio
Although financial institutions do not publish their mortgage screening criteria, it is said that they calculate based on gross salary, and if that figure is up to 30-35%, the application is often approved.
However, based on my experience as a financial planner, I believe that for the borrower to repay the loan comfortably over a long period and pay it off, it is safer to calculate based on net salary and keep the ratio around 20%.
3-3 The 5-year, 125% rule for variable interest rates
Furthermore, when you take out a mortgage with a variable interest rate, it is important to be well-versed in the following two rules.
・5-Year Rule: Even if interest rates rise during the repayment period, the monthly repayment amount remains unchanged for 5 years, and the repayment amount increases from the 6th year.
・125% Rule: Even if the repayment amount is reviewed after 5 years, it will only increase up to 1.25 times (125%) of the previous repayment amount. For example, if you were repaying 100,000 yen, even if interest rates rise, the new repayment amount will be up to 125,000 yen.
What you should be careful about is that the repayment amount is a fixed amount consisting of principal repayment and interest payment. Therefore, when these two rules are applied, unpaid interest may occur, or the amount that cannot be fully repaid at the end of the repayment period may have to be paid in a lump sum, or the repayment period may be extended.
This handling differs for each financial institution. Also, there are financial institutions that do not have these rules. When signing a mortgage repayment contract, it is better to ask the financial institution whether these rules apply.
4 Summary
When purchasing a home, you may be concerned about the mortgage repayment interest rate. Also, some people may choose a financial institution based on this interest rate.
However, the amount of ‘money you can borrow’ from a financial institution and the amount of ‘money you can reasonably repay’ after purchasing a home are often not the same.
A home purchase is one of the top one or two most expensive purchases in your life. You should prepare carefully before purchasing.
Editor’s Note
‘I want to buy a detached house that I like, but
the budget doesn’t match, what should I do?’
I received a consultation from a certain couple.
While we were talking,
‘Even if we like it,
maybe that house doesn’t like us!?’
They said that and bought another house within their budget!