People with Variable Interest Rate Loans in Trouble as Old Financial Thinking No Longer Applies

Mainstream for Home Loans to Shift to Fixed Interest Rates? In the US, 90% Have Fixed Rates.

With the Bank of Japan’s first rate hike since 2007, the “world of interest rates” has made a comeback. Some predict that the policy interest rate could reach 1% by 2026.

Japan, accustomed to prolonged ultra-low interest rates, faces uncertainty about the future of its economy. What impact will this have on financial products and household finances? We asked financial planner Kenji Matsuoka.

In a press conference following the July 31 monetary policy meeting, Bank of Japan Governor Kazuo Ueda stated that if economic and price conditions progress as forecasted, “We will continue to raise the policy interest rate.”

Subsequently, the financial markets experienced rapid changes due to the Bank of Japan’s rate hike and hints of a rate cut by the US Federal Reserve. The Bank of Japan rushed to contain the situation, with Vice Governor Shinichi Uchida clearly stating in a speech in Hakodate, Hokkaido on the 7th of this month that “In the current unstable financial capital market, we will not raise rates.”

Will there be additional rate hikes or not?

“Most participants in the short-term financial market expect the Bank of Japan to raise the policy interest rate by 0.25% to 0.5% by March 2025. They also anticipate another rate hike in September or October 2025, bringing it to 0.75%. Moreover, there seem to be quite a few economists predicting that it could rise to 1% by the end of March 2026.

When the policy interest rate rises, it affects the interest rates on financial products handled by financial institutions. First, those with loans are likely to face increased burdens. Among these, the increase in home loan interest rates seems to pose a significant headwind for household finances.”

Home loans are broadly categorized into two types: ‘variable interest rate’ loans, where the interest rate is reviewed every six months, and ‘fixed interest rate’ loans, where the rate remains constant.

Variable interest rates are largely tied to the “short-term prime rate” (hereinafter “short-prime”) based on the Bank of Japan’s policy interest rate. Many financial institutions add a fixed margin of about 1% to the short-prime rate to determine the “reference interest rate” for home loans. When the short-prime rate rises, the reference interest rate for variable interest loans also increases, which is reflected in the actual borrowing rate, known as the “applied interest rate.”

On the other hand, fixed interest rates are determined based on the “long-term interest rates,” which are indexed to the yield on 10-year government bonds. Thus, when long-term interest rates rise, fixed interest rates will rise accordingly.

“Following the Bank of Japan’s rate hike, some online banks have increased their variable interest rates. au Jibun Bank announced a 0.25% increase in the reference interest rate for variable rates. Since major banks and regional banks have already announced hikes in the short-prime rate, it is reasonable to expect variable rates to increase as well.”

Currently, about 80% of home loan users are said to choose variable interest rates. However, Mizuho Research & Technologies released the following estimate as of April.

In a world with interest rates (assuming the Bank of Japan raises rates by 0.25% every three months from 2024 to 2026), “households will shift from variable interest rate loans to fixed interest rate loans to avoid future risk of increased interest payments,” and the proportion of new borrowings choosing variable rate loans is expected to decrease in line with rising interest rates. It is projected that by the fiscal year 2026, fixed interest rate loans will account for 80%.

“Currently, the lowest interest rate for the fixed-rate ‘Flat 20’ home loan is 1.46%. If you can endure an interest rate burden of 1.46% with a repayment period of another 20 years and with home loan tax deductions already ended, refinancing from a variable rate to a fixed rate is certainly a viable option.

If you are considering refinancing, it’s better to do it sooner rather than later. Refinancing has advantages such as stabilizing monthly repayment amounts, eliminating concerns about rising interest rates, and making it easier to plan for future expenses like education and retirement.”