According to a survey of the Japan Housing Finance Agency covering home loans from October 2022 to March 2023, 72% of new borrowers picked a variable rate mortgage loan over a fixed rate mortgage loan. If you are like me, you have always wondered why so many borrowers in Japan choose a variable rate over a fixed rate. Everyone knows that currently interest rates are very low, meaning in the future there is nowhere to go but up for variable rate loans. Considering the usual 35-year loan term, it would seem prudent to lock in the loan rate, precisely because interest rates are so low historically. Plus, getting a fixed rate loan makes it easier to create a long-term repayment plan, giving the borrower one less thing to worry about in the future.

Broadly there are the two types of mortgage loans: variable interest rate and fixed interest rate. However, there are permutations to these two types. A popular one is the first ten years fixed, and after ten years, an option to switch to a variable rate loan or stay with the fixed rate. As you can imagine, by changing the type of rate during the term, there can be many different loans possible. For instance, Fukui Bank recently began offering a 50-year variable rate mortgage loan, with the first two years fixed. There are even loan services such as mogecheck.jp to help borrowers compare different loan options.

One key to the popularity of variable rate loans in Japan is the possibility of receiving an ultra-low interest rate. For fixed rate loans (such as the most popular Flat 35), the standard rate for a 35-year mortgage is generally between 2-3% these days. Fixed rate loans are benchmarked against long term interest rates, and since presently long term interest rates are 0.5%-1% higher than short term interest rates, the standard rate for fixed loans is higher. Every bank will have its own standard rate and its own reasons for offering a discounted standard rate, i.e., for offering a preferential interest rate (優遇金利). For example, there is the Flat 35S loan, which provides for a preferential interest rate based on (1) the energy efficiency of the residence, and (2) the earthquake resistance of the residence. Generally if your house qualifies for both, you can receive a discount of 0.25% for the first ten years, and an additional 0.25% discount for the first five years.

In contrast to fixed rate loans, variable rate loans are benchmarked against Japanese short term interest rates. Since currently Japanese short term rates are lower than long term interest rates, the standard rate for variable loans is lower, and accordingly the initial interest on a variable loan offered with a preferential rate is lower. Being married, having a high down payment, having a low ratio of total outstanding loan payments to annual salary (before tax), having stable income, and being at the same job for a long time all are weighed positively by banks when offering an interest rate, whether fixed or variable. Most of the factors which help your loan application be accepted can also help you receive a more preferential interest rate: those deemed a good credit risk are offered a lower rate.  

Over the last few years, Japanese megabanks have been locked in competition with online banks to offer the lowest possible preferential rate for variable loans. Even though the profit margin is low, lenders do this in order to draw customers in so they can pitch more lucrative insurance and asset management services. For instance, in June MUFJ offered a variable rate of 0.345% to those who qualify for all preferential reductions of MUFJ’s standard rate. The online bank SumishinSBI even offered a 0.299% preferential rate to its most qualified borrowers. However, the only way to obtain the lowest offered rate is to apply for a variable rate mortgage loan.

There are other compelling reasons for applying for a variable rate over a fixed rate as well. The so-called 5/125 rule for variable loans provides significant predictability to borrowers, although not all banks adhere to this policy. The ‘5’ of the rule refers to the lender committing to adjust the actual monthly payment amount only once every five years. Although interest on the loan may be adjusted every six months, the payment amount will not change. This means then that you will always have five years notice before you have to pay an increased monthly amount during the term of the loan.

Under the ‘125’ of the 5/125 rule, banks commit only to raise the monthly payment amount a maximum of 125% of the prior monthly payment amount. Therefore, if you get a variable rate loan, in the worst case scenario your payments will only go up once every five years, with a maximum 125% increase every time they do increase. Unfortunately, the 5/125 rule does not typically apply to combination fixed/variable-type loans.

The 5/125 rule plays out like this. If you start with a variable 0.4% rate on a 30 million JPY loan for 35 years, in the first five years you would pay 76,557 JPY a month. If the monthly payment amount goes up 125% of the initial payment in year 6, you would have to pay 95,696 JPY from the beginning of the 6th year on. This 125% monthly payment increase would mean the interest on your loan has changed from 0.4% to 2.0%. If there is another 125% jump in year 11, this would mean a monthly payment of 119,597JPY, and the annual rate going up to 4%. In year 16, another 125% jump in the monthly amount would be an increase to 149,456JPY, or an interest rate increase to 6.7%. The next five year maximum increase in year 21 would be to 186,820JPY, and an interest rate of 10.5%. The next jump up in year 26 would be to 233,525JPY per month and an annual 16.1% interest rate (which is illegal under the Japanese Usury Law, since the maximum rate on consumer loans is 15% per year).

In sum, the trade-off between a fixed and variable rate loan is that with a fixed rate, you run the risk of locking in paying more total interest during the term than with a variable rate, although the rate remains fixed. With a variable rate loan, you start with a much lower interest rate. If the interest rate goes up, generally your monthly payment will increase only once every five years. Most people decide to apply for the lowest initial interest rate they can get, knowing that the 5/125 rule means any future increases will be gradual. If they don’t want to hold the asset in the long term, or circumstances change, they can sell. Furthermore, considering Japan’s demographic issues, most people deem it unlikely for rates to go up that significantly in the mid to long term. The low initial monthly payments for a variable rate loan (compared to a fixed loan) seem worth the risk.