Anticipation: How high will mortgage interest go?

May 7th, 2013 by Philip Brasor & Masako Tsubuku

Of course, you can always pay cash

Of course, you can always pay cash

Just as deposit interest rates have remained near zero for the past 20 years in Japan, housing mortgage interest rates have been lower here than almost anywhere else in the world. The effect of the latter has been almost counter-intuitive. Low interest usually spurs investment in real estate and home sales but Japan’s economic situation, not to mention its housing environment, is so odd to begin with that this hasn’t proved to be the case. Younger people thinking about buying homes have lived with low interest rates for so long that they think it’s the norm.

Last week interest rates for housing loans increased by 0.05 percent, the first rise in three months. Interest rates for loans are based on 10-year-bond interest rates. The Bank of Japan, on behalf of the prime minister, is gunning for a two percent inflation rate, and in order to achieve that goal it announced plans to buy government bonds from banks. Anticipating the BOJ’s move, investors have started to sell their bonds. When the price of bonds goes down the interest they pay goes up. More people sold bonds than the BOJ projected, which may not make the government happy since in the long run it will have to pay that interest to bondholders. If consumer prices and, in turn, salaries go up, that won’t be a problem since the government can collect more taxes as a result, but if inflation doesn’t kick in then it just means even more government debt.

Consumers are more concerned with how the change in interest rates will affect them directly. A recent article in Aera profiled a working couple in their 30s who have decided to buy a condominium in Tokyo right away in anticipation of the consumption tax rise next year. Because they both want to be near their workplaces, they settled on an area where the price of a condo that fits their lifestyle is about ¥50 million. They only have ¥3 million for a down payment, and they chose a variable interest rate because it’s lower than a fixed rate right now. Aera asked a financial planner about their situation and the planner seemed dubious.

The couple says they can afford to pay ¥1.2 million a year “comfortably,” which is possible when interest is one percent, as the variable rate they are looking at now stands. But if that rate goes up the couple may eventually be saddled with a higher monthly payment, which means they would have to refinance with a fixed interest rate that would also be higher. The planner estimates that, in order to play it safe, they shouldn’t buy a condo that’s more than ¥32 million.

Though the rate will change depending on the bank, at the moment variable rates range from 0.1 to 1.0 percent, and fixed rates from 1 to 3 percent. The rate also depends on the borrower’s risk factors — income, employment history, assets — and the length of the loan. The greater the risk and/or the longer the loan, the higher the rate. In comparison, rates in the U.S. are between 3 and 4 percent, which is considered low there.

To give some idea of how one should plan for higher interest rates, if you take out a 35-year loan for ¥30 million with a fixed rate of 1 percent, your total interest payments will be ¥5.57 million. If the rate is 3 percent, the total interest payments will be ¥18.49 million, or equal to more than half your principal. Another way of looking at it: if you borrow 10 million to be paid back in 10 years and your rate is 3 percent, you pay ¥96,000 a month.

Variable rates are subject to change every six months, and under conventional contracts the monthly payment stays the same for five years, so if the rate goes up in the meantime, it means a greater portion of the monthly payment goes to interest, thus leaving more of the principal unpaid for the future. Also, if and when you refinance (karikaeru), there are a lot of fees to consider and you will have to resubmit all the documents you submitted for the initial loan. If your circumstances have changed in the meantime, the bank may charge you higher interest. Just the fees for refinancing can exceed ¥500,000. Taking all this into consideration, financial planners use a yardstick to determine whether or not a borrower should refinance. If there’s 10 years left on the mortgage and the balance is less than ¥10 million, you should change to a different interest rate style if that rate is at least 1 percentage point lower than your current rate. Anything less won’t make a difference.

So while variable rates (hendo-gata) are lower right now, the borrower is less certain of how the financing will change over time. Full-term fixed rates (zenkikan kotei-gata) may be higher, but the borrower will know exactly what he or she pays per month over the course of repaying the loan. There are also financing plans called kotei kikan sentaku that offer the chance to choose new fixed rates after 3, 5 or 10 years.

The big question, of course, is how high will interest rates go? It’s impossible to predict, but during the height of the bubble period mortgage interest was 8.5 percent. During so-called normal periods it hovered between 4 and 6 percent, but, as mentioned earlier, things haven’t been “normal” for 20 years.

There were 34,000 auctions of foreclosed properties in 2012, and not all of those were of homes bought during the bubble period. Another yardstick economists recommend is not buying a property where the annual mortgage payment amounts to more than 20 percent of your annual income. As it stands, a good many people are spending 25, and a few think they can go higher with these low interest rates. They may be in for a shock.

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