Understanding the Reverse Compound Effect in Mortgages
Compound interest is an ally in wealth building, but it becomes an adversary when it comes to debt. In the case of equal monthly payment (ganri kinto) mortgages, while the monthly payment is constant, the breakdown in the early repayment period has a larger proportion going to interest, with principal reduction being slow. For a 30 million yen loan at 1.5% interest over 35 years, the total repayment is approximately 38.58 million yen, with total interest of approximately 8.58 million yen - equivalent to 28.6% of the principal.
Looking at the early repayment breakdown makes this structure even clearer. The monthly payment is approximately 91,855 yen, but in the first payment, interest accounts for 37,500 yen and principal repayment for 54,355 yen. Interest comprises 40.8% of the payment. Even at the 10-year mark (payment 120), interest is still approximately 26,000 yen, or 28.3% of the payment. This means the earlier you make prepayments, the more future interest you can eliminate.
Term-Shortening vs. Payment-Reduction - Comparing Interest Savings
There are two types of prepayment: "term-shortening" and "payment-reduction." Let's compare using a 30 million yen, 1.5%, 35-year loan with a 2 million yen prepayment in year 5. With term-shortening, the repayment period is shortened by approximately 2 years and 10 months, and interest savings are approximately 1.2 million yen. With payment-reduction, the monthly payment decreases by approximately 6,500 yen, but interest savings are only approximately 650,000 yen.
Looking solely at interest savings, term-shortening is overwhelmingly advantageous. However, payment-reduction also has rational uses. When you want more monthly cash flow flexibility - for example, during periods of heavy education expenses or when there is a risk of temporary income reduction from a job change - reducing the monthly burden through payment-reduction serves as a household safety valve. The 550,000 yen difference in interest savings can be viewed as an insurance premium for household flexibility.
Prepayment vs. Investing - Where Is the Break-Even Point?
Whether to allocate funds to prepayment or investing is determined by comparing the mortgage interest rate with the expected investment return. At a 1.5% mortgage rate, prepayment is equivalent to "earning a guaranteed 1.5% annual return." Meanwhile, the long-term expected return of a stock index is 5-7% per year, but it comes with risk (price volatility).
The comparison becomes even clearer on an after-tax basis. During the period of the jutaku loan koujo (housing loan tax deduction, 0.7% of year-end balance, up to 13 years), the effective borrowing cost drops to 1.5% - 0.7% = 0.8%. Exceeding this 0.8% through investing is easy. Therefore, during the mortgage tax deduction period, prioritizing NISA investments over prepayment is rational. After the deduction period ends, compare the loan rate with the expected investment return (after tax), and prioritize prepayment if the loan rate is higher.Mortgage strategy books provide detailed explanations of these decision criteria with case studies.
Prepayment Strategy for Rising Interest Rate Scenarios
For variable-rate borrowers, prepayment is worth considering as a hedge against interest rate risk. Even if the current variable rate is 0.5%, a rise to 2.0% would significantly increase monthly payments. For a 30 million yen, 35-year loan, the monthly payment at 0.5% is approximately 77,875 yen, but at 2.0% it jumps to approximately 99,378 yen - an increase of 21,503 yen per month, or approximately 260,000 yen per year.
A practical strategy for preparing for rate increases is to accumulate prepayment funds while rates are low and make a lump-sum prepayment when rates rise. For example, setting aside 20,000 yen monthly for prepayment builds 1.2 million yen over 5 years. If rates don't rise, redirect the funds to investing; if they do, use them for prepayment. This "standby fund" strategy is a flexible approach that addresses both interest rate risk and investment opportunity.
Next Steps to Organize Your Prepayment Decision
First, confirm your mortgage balance, interest rate, remaining term, and remaining years of the jutaku loan koujo (housing loan tax deduction). Next, determine the amount of surplus funds available for prepayment. During the tax deduction period, prioritize allocating surplus funds to NISA systematic investments. After the deduction period ends, compare the loan rate with the expected investment return (after tax), and consider term-shortening prepayment if the loan rate is higher. For variable-rate borrowers, also proceed with building a standby fund for rate increases in parallel. Compound interest can be both ally and enemy. Controlling the "reverse compounding" of a mortgage is the key to accelerating overall household wealth building.