What happens to repayments when mortgage interest rates rise? The '5-year rule' for variable rates and key points on early repayment

Recently, I’ve been hearing talk on the news about interest rates rising or being about to rise.

With both housing prices and interest rates going up, homes are becoming increasingly difficult to buy. For those who have already purchased, it’s a case of ‘lucky you,’ but for those with variable-rate mortgages, this is somewhat worrying news.

We have summarized what we talked about on the radio, as a couple who runs a company while raising children. My husband is more knowledgeable about money matters, and I am usually the one who asks silly questions while having a drink, like ‘How should I think about this?’, and gets him to explain it to me. Please read this as general advice. I would be happy if those of you who are not good with money, like me, could follow along.

By the way, the ‘dish of the day’ I introduced at the beginning of the radio show was a frozen omelet rice from the Seikyo Co-op.

I used to call myself ‘Omuko’ and even included it in my email address because I loved omelet rice so much; I’ve probably eaten all the famous omelet rice in Tokyo. At 38, that was the first time I’d ever eaten Co-op’s omelet rice. It’s different from the fluffy omelet rice at restaurants, but I thought it was delicious in its own way.
It comes in a pack of two for around 450 yen, which is a little over 200 yen each—cheap, small, and the perfect size to just pop out for the kids.
My eldest child has an egg allergy, so I haven’t lived a life where I serve omelet rice to my kids, but after serving it to my son for the first time, I thought that children eating omelet rice are just so cute.

When interest rates rise, the interest you pay increases

When interest rates rise, it means that when you borrow money from a bank, such as for a mortgage, the interest you have to pay back increases.
For example, imagine a situation where you previously borrowed 1 million yen and only had to pay back 1.2 million yen, but now you have to pay back 1.5 million yen.

Until now, we have had a long period of so-called zero interest rates that continued to fall after the bubble burst. At its most extreme, it was as low as 0.something percent, making it an era where it was better to borrow and easier to buy a home.

Why was that the case?
Construction demand is the quickest way to stimulate the economy through consumption. Houses are expensive, so a large amount of money moves at once.
It involves many companies, not just the house manufacturer, but also subcontractors, building material companies, and sales companies, and it allows for higher labor costs.
Condominiums are also very cost-effective economically, as dozens of units can be built on the same land for about the same price as a single house.
There was also a trend of longing to live in a new condominium or a tower mansion.

Ten years ago, people said that ‘housing prices will fall once the Olympics are over.’
People were saying it as if prices would crash, claiming ‘It’s dangerous if you don’t buy before the Olympics’ or ‘Toyosu is in trouble.’
However, although the Olympics were postponed by a year, when we opened the lid, prices had actually risen. I feel that there are various influences at play, not just the Japanese economy.

Why those who borrowed with variable interest rates are worried now

With housing prices said to be at an all-time high, it is also said that interest rates will rise.
It would take too long to explain the reasons for that, but we have reached a point wherewe are raising rates that were previously too low for economic reasons.

This is where people who chose variable interest rates get into trouble. When taking out a mortgage, variable interest rates look overwhelmingly lower and more attractive.

When buying a home, banks and sellers are required to explain that ‘since it is variable, there is a possibility that it will rise.’
It’s the same as having to say ‘there is a possibility that stock prices will fall’ when investing. However, that is followed by some mumbling sales talk, and you are shown a simulation of what the interest rate might look like for 20 years out of a 35-year loan.

Because of this, many people choose variable interest rates; I suspect at least half or more do. Some people also structure their loans with a fixed rate for the first 10 years and variable for the next 10.

Originally, fixed interest rates were higher, and in an era where you could borrow at 0.something percent, a 35-year fixed rate was around 1 to 2 percent.
Since the amount borrowed is large, the difference in that percentage adds up to millions of yen in total. It is natural that many people choose variable rates after seeing the simulation.

Policy interest rates and mortgage interest rates that vary by person

On September 18, it was decided that the policy interest rate would rise from 1% to 1.25%. It is said that there is a trend for it to continue to rise.
The policy interest rate mentioned here is the benchmark interest rate set by the government. The mortgage interest rates we borrow at are raised by banks based on their own judgments in response to that policy rate. Each bank is different in terms of ‘how many percent we will raise it,’ and it also differs depending on your income profile.
For example, civil servants get lower interest rates, employees of highly stable large companies also have an advantage, and it changes based on the company’s rank. Self-employed people like us sometimes struggle to borrow.

The amount you borrow depends on your family’s circumstances

It is actually better to have a high cash ratio and only borrow a few million yen.
If you can buy it with cash, it is better to buy it with cash without borrowing.

However, if buying with cash makes your life difficult, or prevents you from traveling or buying a car, it might be better to borrow some of the money. Everyone’s circumstances are different.

On the other hand, many people take out full loans, or borrow 90% or 80% of the home value, and those people will be in trouble if variable interest rates rise. For example, you might have expected to pay 80 million yen for a house, but before you know it, you end up paying 85 million yen. It is possible that the total amount paid could reach that level.

However, that is the risk of choosing a variable rate, a risk you took from the start. There is the option of refinancing, or the option of selling. There are really many possibilities, so it cannot be said definitively. It depends on the individual’s situation.

Even if interest rates rise, it doesn’t change immediately. The ‘5-year rule’ and early repayment

Just because a bank’s interest rate goes up does not mean your repayment amount changes immediately. There is generally something called the ‘5-year rule,’ where even if interest rates rise, the actual repayment amount only increases after five years.

During these five years, you can decide to sell if you’ve had enough, or you can choose to make early repayments. Interest is charged on the remaining balance, which is the principal.

Even if you start with 50 million yen, if you reduce it to 30 million yen, the amount of interest charged will be compressed, even at a higher rate. Therefore, early repayment is similar to a form of investment. If things are going well now, you can borrow at a variable rate, and if things start looking bad, you can work hard to save during those five years, pay off a large chunk at once, and reduce the remaining balance—that is another strategy.

In other words, there is a little bit of a grace period, giving you time to think. You aren’t being told to ‘decide right now’ in an instant. This is where it differs from investing in FX or stocks.

Financial knowledge isn’t taught in school. So it should be taught at home

You don’t learn about these kinds of interest rates in school.

However, it is something that affects your daily life. My family rents, and since my parents run a car dealership, we borrow cars from them, so we don’t have loans for big purchases like houses or cars. But if you live a normal life, many people will take out a loan for a car or a house. This means it is necessary knowledge as general education, and it is inseparable from daily life. I think it should be included in school curricula.

I hear that financial education is being introduced little by little in high schools, but shouldn’t it be done more seriously? It would be a problem if children grow up without knowing these things. I think we are in an era where ‘I don’t know’ is no longer an acceptable excuse.

Recently, it has become possible to consult with AI. However, stories about AI acting maliciously are also emerging. If you get a sales pitch from an AI, that would be the end of it.

Since you never know what will happen, you really have to study properly yourself and acquire a certain level of economic and financial knowledge. If schools won’t teach it, parents need to provide financial education to their children. Knowing or not knowing about simple versus compound interest makes a difference, and if you just say ‘NISA seems difficult, so let’s skip it,’ your children will end up the same way. Money matters need to be learned somewhere.

When I talk to working professionals or insurance agents, I often hear stories about how their parents struggled or how their parents’ self-employed business was difficult. From there, they realize they need to manage their money properly and study on their own. It’s a spirit of defiance. Because their parents had a hard time, they decide to study for themselves.

If possible, it would be best if parents could teach their children little by little, and I believe it should be properly incorporated into education, regardless of one’s environment.

Those who have realized this are studying on their own using things like YouTube. My husband also started by studying on YouTube. Of course, there is ‘positional talk’ in financial discussions, so you need to think about whose advice to trust, but basically, there are many people sharing correct knowledge.

YouTube or books, either is fine. I am also learning little by little. If you are not good at talking about money, why not start by watching some videos?

Once you have a clear outlook on your finances, it becomes easier to think about choices like how you will work in the future and what kind of lifestyle you will choose.