victoria37
New member
Yesterday, the Bank of Japan ended its negative interest rate policy and increased interest rates for the first time in 17 years. In addition, it also announced it will be stopping yield curve control on long-term government bonds. At the same time, the Bank expects "accomodative financial conditions to be maintained for the time being".
That's the headline and summary of what the Bank did. So what does this all mean for people with a mortgage or those looking for a mortgage?
For fixed rate mortgages, they are generally based on the 10-year Japanese government bond yield around the date the loan is transacted. This rate is determined at a market auction by bond investors. This rate has been controlled by the Bank of Japan so far through yield curve control, although control has been gradually relaxed for the past couple of years. This has been reflected in the change in interest rate applied to new fixed-rate mortgages. Once the terms are agreed on and the deal closed, the interest rate applied to the mortgage will not change, hence "fixed-rate".
For variable rate mortgages, banks simply give discounts (引き下げ and 優遇金利) on the basic interest rate (基準金利 or 店頭金利) to get the actual applied interest rate (適応金利). In the case of a typical 35-year variable rate mortgage, the discount is fixed when the transaction occurs and will not change over the course of the loan. This means the only thing that can affect the interest rate will then be changes in the basic interest rate. (There are products where the discount changes over the course of the loan, typically fixed-then-variable loans.)
The basic interest rate is determined by the bank based on market and business conditions.
For the megabanks and and Sumishin SBI Net Bank, the basic interest rate for variable rate home loans is set at +1% from the short-term prime lending rate (短期プライムレート). The short-term prime lending rate is what banks charge "on loans to firms with high ratings in their sectors" for loans of less than one year. This rate affects far more than just home loans, and affects a bank's competitiveness when attracting major corporate borrowers, so generally banks will not differ too much each other.
For net banks and some city banks, the rate is actually determined in a less-transparent manner based on business conditions, but again because it affects the bank's competitiveness, rates should not stray too far from the norm. For example, Paypay Bank's basic rate actually went down from 2.315% to the current 2.28% between October 2019 and July 2020. For more details, see this video.
There are also some banks where the basic interest rate is determined by TIBOR (Tokyo Interbank Offered Rate) or by the long-term prime lending rate. The TIBOR is closely-related to the Bank of Japan's policy rate, while the long-term prime lending rate is actually influenced by the bond market for long-term bonds.
The two relevant decisions made by the Bank of Japan are
If you are on a fixed-rate mortgage, nothing will change.
If you are on a variable-rate mortgage, then it'll depend on how your bank determines their basic interest rates, and how your bank actually revises the interest rates on your loan.
First, about basic interest rates.
Paypay Bank's basic interest rate is revised twice a year on April 1 and October 1. The rate in April will be applied the day after the the June repayment, and the rate in October will be applied the day after the December repayment. Subsequent repayments will immediately reflect changes to the interest rate.
Mizuho Bank takes the typical megabank approach. Interest rates are revised twice a year on April 1 and October 1. For people on fixed principal amortization (元金均等) the revised interest rate is immediately reflected in the subsequent payments, because monthly payments are just a fixed principal + interest. For people on the more-typical fixed payment amortization (元利均等), while interest rates are revised twice a year, actual repayments are only revised about every 5 years (specifically, on every fifth October 1.) This means any changes in interest will remain unpaid and compound until the repayment amount is revised or an early repayment is made. In addition, when repayments are revised the new repayment is capped at 125% of the previous amount. Unpaid interest exceeding that will continue to compound in the background. This is the so-called "5-year/125% rule" and as you can see not all banks follow this, and it does not mean you don't have to pay interest.
Therefore, even if the basic interest rate does change, you may have some time to prepare before the repayment amount actually changes.
For people looking to borrow a fixed-rate mortgage, the end of yield curve control means rates on new fixed-rate mortgages may increase. This is because the rate of fixed-rate mortgages are closely related to the yield of 10-year Japanese government bonds. In fact, new fixed-rate mortgages are already quite a bit more expensive than a couple of years ago.
For people looking to borrow variable, how the basic interest rate will change is described above. There is a chance banks may start to reduce their discount rates going forward because there's now quite a bit less incentive to lend at rock-bottom 0.2%, 0.3% rates now that the Bank of Japan is paying 0.1% on deposits. This will not affect existing borrowers but will affect new borrowers. What's clear is that trend of discounts getting larger and interest rates getting lower has come to an end for the time being.
I am not an economist or a financial expert, and if I knew I'd be making a lot of money. Ask 10 experts and you'll get 10 different views.
However, three points:
I wrote this last January and my thoughts haven't changed.
That's the headline and summary of what the Bank did. So what does this all mean for people with a mortgage or those looking for a mortgage?
The basics
For fixed rate mortgages, they are generally based on the 10-year Japanese government bond yield around the date the loan is transacted. This rate is determined at a market auction by bond investors. This rate has been controlled by the Bank of Japan so far through yield curve control, although control has been gradually relaxed for the past couple of years. This has been reflected in the change in interest rate applied to new fixed-rate mortgages. Once the terms are agreed on and the deal closed, the interest rate applied to the mortgage will not change, hence "fixed-rate".
For variable rate mortgages, banks simply give discounts (引き下げ and 優遇金利) on the basic interest rate (基準金利 or 店頭金利) to get the actual applied interest rate (適応金利). In the case of a typical 35-year variable rate mortgage, the discount is fixed when the transaction occurs and will not change over the course of the loan. This means the only thing that can affect the interest rate will then be changes in the basic interest rate. (There are products where the discount changes over the course of the loan, typically fixed-then-variable loans.)
The basic interest rate is determined by the bank based on market and business conditions.
For the megabanks and and Sumishin SBI Net Bank, the basic interest rate for variable rate home loans is set at +1% from the short-term prime lending rate (短期プライムレート). The short-term prime lending rate is what banks charge "on loans to firms with high ratings in their sectors" for loans of less than one year. This rate affects far more than just home loans, and affects a bank's competitiveness when attracting major corporate borrowers, so generally banks will not differ too much each other.
For net banks and some city banks, the rate is actually determined in a less-transparent manner based on business conditions, but again because it affects the bank's competitiveness, rates should not stray too far from the norm. For example, Paypay Bank's basic rate actually went down from 2.315% to the current 2.28% between October 2019 and July 2020. For more details, see this video.
There are also some banks where the basic interest rate is determined by TIBOR (Tokyo Interbank Offered Rate) or by the long-term prime lending rate. The TIBOR is closely-related to the Bank of Japan's policy rate, while the long-term prime lending rate is actually influenced by the bond market for long-term bonds.
What actually happened yesterday?
The two relevant decisions made by the Bank of Japan are
- Ending of the negative interest rate policy. To quote the Reuters news report, "the BOJ set the overnight call rate as its new policy rate and decided to guide it in a range of 0-0.1% partly by paying 0.1% interest to deposits at the central bank." You can read more about the overnight call rate at the BoJ's FAQ but generally speaking it just means the policy rate got hiked by between 0.1% to 0.2%.
- Ending of yield curve control. This means the Bank of Japan will stop buying 10-year government bonds for the purpose of artificially suppressing interest rates. This is a follow-up to a decision made last October to relax yield curve control by targeting a 10-year government bond yield of about 1% instead of 0.5%.
So how will mortgage rates change for an existing borrower?
If you are on a fixed-rate mortgage, nothing will change.
If you are on a variable-rate mortgage, then it'll depend on how your bank determines their basic interest rates, and how your bank actually revises the interest rates on your loan.
First, about basic interest rates.
- If tied to the short-term prime lending rate, yesterday's decision likely wouldn't change anything for the time being. Short-term prime lending rates have not changed since 2009. The negative interest rate policy was adopted in February 2016, so that did not affect short-term prime lending rates. It's fair to assume the ending the negative interest rate policy would not affect the short-term prime lending rate.
- If tied to business conditions, there's a possibility banks would react to the change faster, and modify their basic rate. However, it's very unlikely the hike would be more than 0.2%.
- If tied to TIBOR, it's slowly inching up, but again it would be very unlikely the rate would increase by more than 0.2%.
- If tied to the long-term prime lending rate, you've experienced a lot of ups and downs already. It's harder to put an upper bound on an increase but you're probably already used to this.
Paypay Bank's basic interest rate is revised twice a year on April 1 and October 1. The rate in April will be applied the day after the the June repayment, and the rate in October will be applied the day after the December repayment. Subsequent repayments will immediately reflect changes to the interest rate.
Mizuho Bank takes the typical megabank approach. Interest rates are revised twice a year on April 1 and October 1. For people on fixed principal amortization (元金均等) the revised interest rate is immediately reflected in the subsequent payments, because monthly payments are just a fixed principal + interest. For people on the more-typical fixed payment amortization (元利均等), while interest rates are revised twice a year, actual repayments are only revised about every 5 years (specifically, on every fifth October 1.) This means any changes in interest will remain unpaid and compound until the repayment amount is revised or an early repayment is made. In addition, when repayments are revised the new repayment is capped at 125% of the previous amount. Unpaid interest exceeding that will continue to compound in the background. This is the so-called "5-year/125% rule" and as you can see not all banks follow this, and it does not mean you don't have to pay interest.
Therefore, even if the basic interest rate does change, you may have some time to prepare before the repayment amount actually changes.
How will rates change for people looking to borrow?
For people looking to borrow a fixed-rate mortgage, the end of yield curve control means rates on new fixed-rate mortgages may increase. This is because the rate of fixed-rate mortgages are closely related to the yield of 10-year Japanese government bonds. In fact, new fixed-rate mortgages are already quite a bit more expensive than a couple of years ago.
For people looking to borrow variable, how the basic interest rate will change is described above. There is a chance banks may start to reduce their discount rates going forward because there's now quite a bit less incentive to lend at rock-bottom 0.2%, 0.3% rates now that the Bank of Japan is paying 0.1% on deposits. This will not affect existing borrowers but will affect new borrowers. What's clear is that trend of discounts getting larger and interest rates getting lower has come to an end for the time being.
How will rates change going forward?
I am not an economist or a financial expert, and if I knew I'd be making a lot of money. Ask 10 experts and you'll get 10 different views.
However, three points:
- As the Bank has stated, "accomodative financial conditions" will be maintained for the time being, so dramatic changes in rates are highly unlikely. And "dramatic" in Japanese terms means like, 1%. This is a country with an entire generation of bankers who have never been in an environment with positive interest rates.
- Whether the Japanese economy can handle sustained interest rate hikes is a huge question mark. Wages are increasing at some large companies but not small and medium companies. The central bank is betting that increased wages at large, profitable companies (many of which are international businesses and buoyed by the weaker yen) will trickle down to the local economy where most small and medium companies do their business, then small and medium companies will have the finances to significantly raise wages. The results of this will take some time to be observed.
- If coupled with wage raises and healthy inflation, an increase in interest rates is not a bad thing. Some amount of interest is a sign of a strong, functional economy. In the best-case scenario where the Bank of Japan and the government manage to normalize the Japanese economy, we can expect a good job market where most people have wage increases either via raises or job-switching exceeding the increase in monthly repayments.
Should I get a fixed rate or variable rate mortgage now?
I wrote this last January and my thoughts haven't changed.