Getting a Variable Rate Home Loan in Japan? Beware the 5-Year Rule

By Jeff Wynkoop

Mortgage rates in Japan are historically low, and a majority of borrowers don’t think interest rates are going to go up any time soon. In its April 2019 meeting, the Bank of Japan was clear in announcing that they expect to maintain the current low interest rate environment until at least the spring of 2020.

New all-time high of borrowers choosing variable rate mortgages

The low rates have had a trickle-down effect in the mortgage market, with a new all-time high of 57% of all borrowers in April-Sept 2018 picking a full-term variable interest rate loan, while a full-term fixed rate mortgage appealed to less than 20% of new borrowers (according to data from the Japan Housing Finance Agency).  The rest of the mortgage loan market is made up of mortgages with fixed terms of various lengths, followed by a variable rate period. Ten years ago, variable mortgages with an initial 10-year fixed term were the most popular in the market, but not anymore.

The leading interest rate for the Flat 35 loan was 1.29% in May 2019, which is over double the rate some megabanks are giving their preferred customers for full-term variable rate mortgage loans (the lowest of which is 0.525%). A 0.525% variable loan may seem a lot cheaper than a 1.29% fixed loan, but when interest rates change, it is harder to keep track of your mortgage costs with a variable rate loan. The reason for this difficulty is the so-called 5-year rule.

What is the 5-Year rule?

The 5-year rule is the internal bank rule that for five years after interest rates change, the bank will maintain the same monthly payment amounts for borrowers. There is also the 125% rule, which causes some banks to cap any increase to 125% of the monthly payment amount of the prior 5-year period. The point is to try to ‘help’ borrowers and protect them from sudden fluctuations in monthly payment amounts.

How do banks afford this you may ask? If interest rates go up, but monthly payments do not, what is going on? Lenders, of course, still make their money. They do this by lowering the amount of the monthly payment allocated to paying back the principal, and increasing the percentage that goes to paying back interest. In this way, banks can stretch out the term of variable rate mortgage loans by making it take longer to pay back loan principal. And the increased cost can be harder for the borrower to notice, since the monthly payment amount doesn’t change for many years after interest rates rise. Although there are some financial institutions that have done away with this paternalistic 5-year rule, this is very important to ask about when applying for and comparing variable and fixed rate mortgages at different banks.

There is, however, another ‘5-year’ rule that you should keep in mind some banks like to ignore to their borrower’s detriment: the rule that ideally the total loan principal should not exceed 5 years of the borrower’s after-tax salary (not counting any bonus). Instead, borrowers and lenders can justify an unduly high variable loan amount when they calculate backwards from a desired monthly payment (for instance, a 100,000 JPY monthly payment at 0.525% for 35 years equates to a loan principal amount of 38.35 million JPY). With real estate prices continuing to edge higher, it can be easy for unscrupulous salesmen to convince a borrower to borrow as much as possible to afford their dream home. When interest rates rise in the future however, the total cost of their new mortgage may be more than the borrower bargained for.

Applying for a home loan as a foreigner in Japan

As a foreigner in Japan, your residency status can significantly affect the financing terms for which you are eligible. If you are a Permanent Resident of Japan, local banks will give you much better financing terms than they would for working-visa holders. You can learn more about this at one of our upcoming seminars.

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Real Estate Japan Seminars

Please see our seminar page for a current list of seminars on: how to buy a home in Japaninvesting in Japanese real estate for beginnershow to apply for permanent residency in Japanhow to sell property in Japan, and much more.

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