The short version
If you use a variable-rate loan for real estate investing, you may hear this line:
Even with a variable rate, your monthly payment won't jump suddenly, so you're fine.
It's true that some variable-rate home loans in Japan come with the so-called "5-year rule" and "125% rule."
But these are not a way to make interest rate risk go away.
They only soften sudden changes in the monthly payment, and only for a while.
When rates rise, more of each payment goes to interest, and the principal can shrink more slowly. In some cases, unpaid interest can pile up.
In other words:
The payment hasn't gone up yet
≠ Rising rates aren't affecting you
What really matters in real estate investing isn't how the payment looks on paper. It's whether your rental business can still hold up after rates rise.
What are the "5-year rule" and the "125% rule"?
These two rules come up all the time when variable rates are explained.
The 5-year rule
Even if the interest rate changes, the monthly payment stays the same for a set period.
This idea is generally found in home loans repaid in equal installments of principal plus interest (the payment stays level, and the split between interest and principal shifts over time).
Even if rates go up, your monthly payment doesn't rise right away.
But what the payment is made of does change.
When rates go up, a bigger share of each payment goes to interest, and a smaller share goes to paying down principal.
The 125% rule
When the payment is reviewed, the new amount is capped at 125% of the previous one, even if the rate increase would push it much higher.
For example, if you were paying 100,000 yen a month, the payment after the review can go up to 125,000 yen at most.
That sounds reassuring.
But all this rule protects is a sudden jump in the monthly payment.
It doesn't stop the interest rate itself from rising.
The real danger is thinking the interest burden has vanished
Even with the 5-year and 125% rules, a higher rate means a heavier interest burden.
If the monthly payment stays the same, the extra interest is simply absorbed inside that payment.
So this happens:
Rates rise
↓
The interest part grows
↓
The principal part shrinks
↓
Principal comes down more slowly
And if rates climb sharply, interest can end up larger than the monthly payment itself.
That's when unpaid interest appears.
Unpaid interest is not money you're excused from paying.
It's just pushed to later.
So the 5-year and 125% rules are
not a mechanism that removes interest rate risk
but rather
a mechanism that smooths out sudden changes in your payment
Get this wrong and you'll be far too relaxed when you work out whether a property pays for itself.
Investment property loans may not have the same rules at all
Another important point: the 5-year and 125% rules are mostly talked about in the context of home loans.
For investment property loans and apartment-building loans, the terms differ by bank and by product.
So thinking
It's a variable rate, so it must have the 5-year and 125% rules, right?
is risky.
Before you sign, check at least the following:
・Is there a 5-year rule?
・Is there a 125% rule?
・Equal principal-plus-interest payments, or equal principal payments?
・How is unpaid interest handled if it arises?
・How often is the rate reviewed?
・The base rate and the size of the discount
・Can you switch to a fixed rate?
・Fees for early repayment
・A repayment schedule for a scenario where rates rise
With equal-principal repayment in particular (where the principal portion is the same every month), the 5-year and 125% rules may not apply.
Some products also have no cap on how much the payment can change when you switch to a fixed rate.
A payment you thought "wouldn't suddenly increase" may, depending on your contract, simply change.
Rising rates aren't the only thing to fear in real estate investing
Rising rates on their own are something you can still calculate.
What's truly scary is when a rate hike arrives together with other risks.
In real estate investing, risks like these pile up:
・Vacancies
・Falling rents
・Advertising fees (paid to agents to find tenants)
・Restoration costs after a tenant moves out
・Repair costs
・Property tax
・Fire insurance
・Management fees
・Disasters
・Rising interest rates
・Not enough buyers when you sell
Take a whole apartment building that looks great on gross yield. If this all happens together:
Rates go up
Two units sit empty
You have to cut rent to fill them
The water heater or exterior walls need repairs
The management company isn't pulling its weight
your cash flow can collapse in one go.
Real estate investing isn't just buying a property.
What you're actually doing is running a rental business with borrowed money.
That's why judging by gross yield alone is dangerous.
The danger of taking on nearly 30 years of debt on the assumption that "rates won't rise"
Sales brochures and books on real estate investing sometimes show cash-flow simulations that assume low rates.
But if you're borrowing for the long term, it's dangerous to rely only on the assumption that
rates will stay about where they are now.
Nobody knows what rates will be in 10, 20 or 30 years.
And when rates do rise, saying
Nobody told me this could happen
won't get you out of it. Real estate isn't something you can walk away from easily.
Unlike stocks, you can't sell a property with one click.
You have to find a buyer.
And the sale price depends on the interest rates, lending conditions, population trends, the condition of the building and rent levels at that time.
That's exactly why, if you buy property with a variable rate, you should assume from the start that rates might go up.
If you buy with a variable rate, run at least this stress test
Variable rates aren't automatically bad.
If you can borrow at a low rate, it can make it easier to generate positive cash flow.
The problem is buying on the assumption that rates won't go up.
If you use a variable rate for real estate investing, run at least these stress tests:
Rate +1%
Rate +2%
Rate +3%
Vacancy rate 10%
Vacancy rate 20%
Rent decline 5%
Rent decline 10%
Set aside repair reserves every month
Include advertising fees and restoration costs
Include property tax, insurance and management fees
Run the numbers under these conditions, and if you find that
It's only profitable if every unit is full
A +2% rate wipes out almost all the profit
A +3% rate puts you in the red
A few vacancies mean paying out of your own pocket
It doesn't work once repair costs are included
then that property is very risky.
On the other hand, if you find that
It works at current rents
It holds up even at +2 to 3% rates
Cash flow doesn't fall apart when units go vacant
It's still profitable with repair reserves included
You can picture an exit by selling
only then is it worth considering.
What to look at instead of "the payment won't suddenly rise"
For real estate investing with a variable rate, these are the questions to ask:
When, and under what conditions, does the monthly payment change?
When rates rise, how much principal actually gets paid down?
Could unpaid interest build up?
Could the balance be demanded in one lump sum at the final repayment?
What are the conditions for escaping to a fixed rate?
Can I survive vacancies, falling rents and repairs all at once?
Is this an area where I can find a buyer when I sell?
Sales materials naturally put yields and loan approval up front.
But if you plan to hold for the long term, what matters more than yield is how hard it is to break.
An apartment building in particular sees its cash flow change with just one vacant unit.
As the building ages, repair costs go up.
And with properties in rural areas, there's also the risk that they're hard to sell when you want out.
If you're using a variable rate in that setting, the question shouldn't be
The payment won't jump suddenly, so it's fine
but
Can I still hold on if rates rise, units go vacant and repairs come due?
Wrapping up: the variable rate isn't the danger, assuming rates won't rise is
A variable rate isn't bad in itself.
Being able to borrow at a low rate is a big advantage in real estate investing.
But buying on assumptions like
The payment won't jump suddenly
Rates won't rise that much
The rent will cover the loan
Once it's full, the yield is high
is dangerous.
The 5-year and 125% rules don't eliminate interest rate risk.
They can hit you later, in the form of unpaid interest and slower principal repayment.
What matters in real estate investing isn't comforting words but the numbers under bad conditions.
What you should look at isn't the yield at full occupancy.
Current rents
Real expenses
Repair costs
Vacancy rate
Rising interest rates
The exit (selling)
That's the list.
If you buy with a variable rate, don't pray for a future where rates never rise. Choose only properties that won't break even if they do.
Looking at it that coldly is about right for real estate investing, I think.
References (4)
MUFG Bank, "Is a variable rate good for a home loan? Know the pros and cons"
Explains that the 5-year and 125% rules apply to the payment, not to the interest rate itself, and that unpaid interest can arise.
https://www.bk.mufg.jp/column/loan/0011.htmlSMBC (Sumitomo Mitsui Banking Corporation), "The variable rate has gone up. How does it affect my payment?"
Explains the 5-year rule, the 125% rule and how unpaid interest works for equal principal-plus-interest repayment.
https://qa.smbc.co.jp/faq/show/10674Mizuho Bank, "How the variable-rate system works"
Explains the pros and cons of variable rates, the 5-year and 125% rules, and how unpaid interest is handled.
https://www.mizuhobank.co.jp/loan_housing/housingloancost/structure.htmlFinancial Services Agency (Japan), "Results of the survey on loans for investment real estate"
Shows that when lending for investment real estate, it's important to explain risks such as vacancies, falling rents, repair costs, disasters and rising interest rates.
https://www.fsa.go.jp/news/30/20190328.PDF
