In this report, we discuss Japan's residential mortgage loan market in terms of real estate prices, interest rate types, and trends in various indicators, such as housing starts, in addition to characteristics of mortgage loans.

The aim of this report is to help domestic and international investors understand the characteristics of Japan's mortgage loans and RMBS markets.

Overview

The balance of outstanding mortgage loans in Japan has grown by about 2% a year over the past 10 years. S&P Global Ratings attributes the stable growth to an increase in housing demand backed by steady economic growth, cultural factors like homeownership aspiration, and the low interest rate environment. Under the current circumstances of rising interest rates led by the Bank of Japan's (BOJ) monetary policy revision, about 90% of new loans are floating-rate loans, including fixed-rate convertible loans, which have lower initial interest rates than fixed-rate loans. Conversely, the proportion of fixed-rate loans, which are underlying assets for most of the residential mortgage-backed securities (RMBS) transactions, has been declining. Consequently, RMBS issuance has trended downward in recent years following a peak in 2016.

General characteristics of Japanese mortgage loans include: 1) a long loan life of 25 to 35 years; 2) recourse loans, meaning a creditor has the right to seek recovery from assets other than collateral held by a debtor in the event of a mortgage default; and 3) a high proportion of loans with a loan-to-value (LTV) ratio of over 90%.

Characteristics Of Japan's Mortgage Loan Market

1) Market size and main lending institutions

Japan's mortgage loan market measured by the outstanding amount of loans is about ¥216 trillion as of the end of fiscal 2022. The balance of outstanding loans has increased about 2% annually since 2016 in line with the prolonged low interest rate environment.

Domestic banks now account for the largest proportion of new loans by lending institution, occupying about 74% at the end of fiscal 2022 (March 31, 2023). A public institution, the Government Housing Loan Corp. (GHLC; currently Japan Housing Finance Agency (JHF)) was a major lending institution of mortgage loans until around 2000. It offered loan products such as low-interest and long-term fixed-rate housing loans, which ordinary financial institutions did not offer. GHLC played a central role in the government's housing policy by providing direct lending. However, it essentially withdrew from direct lending operations due to a revision of the GHLC Law in 2003. After the reorganization of GHLC into JHF in 2007, JHF has shifted its focus to securitization support business in cooperation with the private sector.

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2) Loan origination standards by lending institutions, LTV and debt-to-income (DTI) ratios, and annual household income

Most Japanese mortgage borrowers buy houses in their 30s and take out mortgages from 25 years to 35 years. Furthermore, most homebuyers use mortgages because the amount of money they spend to purchase homes is large relative to their savings. Taking these borrower characteristics into consideration, financial institutions determine the details of their mortgage loan review.

According to a survey by the Ministry of Land, Infrastructure, and Transport (MLIT), when financial institutions decide whether to lend mortgages, they place particular emphasis on items such as "age at full repayment," "health conditions," "age at borrowing," "collateral assessment," "years of service," "joint and several guarantee," "DTI ratio," and "annual income." Japanese mortgage loans are generally recourse loans, so financial institutions focus on borrowers' ability to repay their loans, in our view.

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According to a JHF questionnaire to loan users conducted in April 2023, loans with high-LTV ratios made up a large proportion of total; with users who have over an LTV ratio of 90% accounted for 39%. The most frequent interval of debt-to-income (DTI) ratio is between 15% and 20%. Ranges of annual household income of ¥6 million-¥8 million and ¥4 million-¥6 million are most common, accounting for about 26% each.

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3) Interest rate type

Results of JHF's questionnaire show floating-rate mortgage loans now account for the largest share, at about 72%. The proportion of full-term fixed-rate loans has been declining, standing at about 9% in the most recent survey, down from about 38% in 2015. We think this is because, with the introduction of the BOJ's negative interest rate policy in 2016, the gap between long-term and short-term interest rates widened in the low interest rate environment, which has made floating interest rates more attractive. In fixed-rate convertible loans, borrowers can choose a fixed interest rate period from multiple options: two years, three years, five years, seven years, 10 years, etc. A proportion of fixed-rate convertible loans has also been declining, standing at about 18% at present.

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There are three major types of mortgage loans by interest rate that financial institutions offer: full-term fixed-rate loans, fixed-rate convertible loans, and full-term floating-rate loans. For full-term floating-rate loans, the frequency of review of interest rates and repayment amounts is similar for all financial institutions. Options for fixed-rate convertible loans after the end of the fixed period vary by financial institution. For example, in the case of three-year fixed-rate convertible loans, borrowers will pay a fixed interest rate for the first three years, then they choose either a floating rate or a fixed rate for a certain period at the start of the fourth year. Moreover, after choosing a floating interest rate, for some loans, borrowers can switch to a fixed interest rate again for a certain period, while for other loans, they cannot.

For a typical floating rate loan, the monthly repayment amount is determined according to the following rules:

(1) The five-year rule:

This is a system for reviewing monthly principal and interest repayments every five years. Regardless of fluctuations in the interest rate applied, the monthly principal and interest repayments are fixed at a certain amount for five years. Although the repayment amount remains unchanged, the breakdown of principal and interest change because the interest rate applied is reviewed periodically (e.g., twice a year). In addition, even if a material rise in interest rates prevents borrowers from fully paying interests even through entire repayments, the repayment amount remains unchanged. However, the accrued interest will be deferred.

(2) The 125% rule:

This stipulates that the amount of principal and interest repayments after the revision every five years will be increased no more than 125% of the previous amount. If the calculated principal and interest repayments exceed 125% as a result of significant rise in interest rates, the excess is not extinguished but is carried forward to the next and subsequent review of the principal and interest repayments.

Table 1

Lending institutions often apply preferential interest rates to mortgage rates. The preferential interest rate refers to the application of an interest rate calculated by subtracting a certain level from an over-the-counter mortgage rate when applicable conditions are met. Regardless of the mortgage loan type, there are two main types of preferential interest rates: one is the rate applied through the entire borrowing period; the other is the rate applied only for an initial fixed period. The extent of preferential interest rates varies by lending institution.

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4) Relay repayment and pair loans

In the case of a mortgage loan for a residence where parents and children live together or plan to live together in the future, borrowers may be able to use parent-child relay repayment or parent-child pair loan. The parent-child relay repayment is a loan that a child will take over in the future from his or her parents who are repaying. In this case, a borrower can take out a loan from a lending institution which determines the loan amount based on the current combined income of parent and child. Therefore, the borrower can receive a larger loan than that the parent or child applies alone and can repay the loan over a longer period.

Parent-child pair loans are a product in which a parent and a child living together each takes out a mortgage. It has the advantage of being more manageable than parent-child relay repayment, because the amount and method of repayment and shared stake are set separately for the parent and the child. In addition, many financial institutions offer pair-loan products, in which a borrower can take out a loan with their spouse.

5) Group credit life insurance and sickness insurance

A lending institution can purchase group credit life insurance in case a debtor dies. In such cases, the entire remaining mortgage debt is paid to the lending institution. For loans provided by JHF, purchasing group credit life insurance is optional. However, most debtors buy the insurance because they cannot do it after the loan is disbursed. Conversely, private lending institutions require their debtors to buy group credit life insurance when taking out a loan, for which they need to clear screening. Group credit life insurance premiums are included in the mortgage rate or collected separately.

In addition to group credit life insurance, housing loans with special provisions for sickness insurance are also offered. The insurer will provide payment of all or part of the remaining mortgage debt in the event that an insured person is unable to continue working due to prolonged hospitalization or other situations resulting from ill health caused by conditions including cancer, stroke, and acute myocardial infarction.

6) Guaranty company and mortgage right

Some mortgage loans require a debtor to obtain a personal joint and several guarantee or a guarantee from a guaranty company. There are three major types of guaranty company: 1) subsidiary of a lending institution (mainly banks), 2) guaranty company jointly owned by multiple lending institutions, and 3) independent guaranty company. Either debtors pay guarantee fees in a lump sum at the time of borrowing or lending institutions add a guarantee fee to the applicable interest rate and pay a portion of the interest.

In Japan, land and buildings are treated as separate properties. A mortgage right is established through registration of the land and buildings of the property to be financed. If there is no joint and several guarantee from a guaranty company, it is common for lending institutions to establish a mortgage right. If there is such a guarantee, in many cases, the guaranty company creates a mortgage with the right to reimbursement for the guaranteed obligation as a secured claim. Mortgages are essentially required to be in a first-priority lien position. Nonetheless, when a borrower uses a mortgage loan provided by a private lending institution in combination with a loan from JHF, most of the time, JHF sets a first-lien mortgage right and the private lending institution establishes a junior mortgage right.

If a debtor defaults, a creditor collects the debt by selling the collateral. The collateral is sold through voluntary sales or auctions. A voluntary sale is a sale of underlying collateral without auction based on an agreement between the debtor and the creditor or the mortgagee. An auction is a method of sale that is enforced by a court without consent of the debtor. Generally speaking, the voluntary sale has advantages such as a shorter collection period and a higher sale price than auction.

7) Environmentally friendly housing

Based on the 6th Basic Energy Plan in 2021, the Japanese government has been promoting net-zero-energy housing (ZEH). The government has set targets to ensure energy conservation performance at the level of ZEH standards for new houses to be built in fiscal 2030 and thereafter, and to aim to install solar power generation facilities in 60% of new detached houses by 2030.

For example, JHF has started to offer a housing loan called Flat 35 (ZEH) since October 2022. If a borrower, who uses the Flat 35 (ZEH) loan, purchases a house that meets thermal insulation performance and energy-saving standards, the interest rate applied will be lowered. In addition, if the house to be purchased meets certain standards for housing performance and maintenance plans that can withstand long-term use, it will be regarded as long-term excellent housing and the interest rate applied to the borrower will be further lowered.

Market Trends Surrounding Mortgage Loans

1) Real estate prices

In September 2023, the residential property price index (nationwide) for condominiums stood at 193.5 and 115.9 for detached houses (arithmetic average of the monthly indices for 2010 is 100), according to data published by the MLIT. Condominium prices have been rising, especially since 2020. Detached house prices are on a similar upward trend, although the increase is relatively small. We believe this is due to stagnant supply chains during the COVID-19 pandemic, rising material prices, and increased housing needs. Moreover, we attribute the relatively large rise in condominium prices to a recent downward trend in new condominium supply and an increase in condominium investment driven by the low interest rate environment.

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2) Interest rates

The BOJ's monetary easing policy has been in place for a number of years. In 2016, the BOJ strengthened the policy through application of negative interest rates to financial institutions' current account at the BOJ and its quantitative and qualitative monetary easing with yield curve control. Yields on 10-year government bonds have risen recently, reflecting a revision of the policy. On the other hand, short-term interest rates have not changed materially. The level of interest rates on floating-rate mortgage loans remains low because such rates are generally determined based on short-term interest rates.

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3) Housing starts

Housing starts are on a long-term downward trend, according to the building starts survey by the MLIT. They were about 860,000 in 2022, about half of the peak in 1990. Breakdown by owner occupant relation shows that, in 2022, the largest share was rental housing, standing at 40.1%, followed by built for sale (29.7%), and owned houses (29.5%).

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4) Employment and corporate bankruptcies

The unemployment rate and ratio of job offers to applicants had been on an improving trend until 2020, after a sharp decline during the financial crisis in 2008. Although both ratios temporarily worsened during the pandemic, the most recent data as of November 2023 shows a recovery trend; the unemployment rate is 2.5% and the job offers to applicants ratio is 1.28x.

Changes in the employment environment indicated by these metrics are closely related to debtors' ability to repay mortgages. Given that many mortgage debtors are employed income earners, we believe the likelihood of delinquencies and loan losses in mortgage repayments would be low, if employment conditions improve, which enables debtors to secure stable, long-term income.

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According to Teikoku Databank Ltd.'s Bankruptcy Report, the number of corporate bankruptcies declined during the pandemic in 2020. We attribute this to the effects of government funding and other support measures. Since then, the number of bankruptcies bottomed out and is now back to pre-pandemic levels with such measures being scaled back as the pandemic subsides.

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5) Prices

The Consumer Price Index (CPI) measures changes in the prices of all goods and services purchased by households nationwide. It is often used as a representative indicator of inflation and deflation. Nevertheless, since the late 1990s, the CPI has remained largely flat, excluding the impact of changes in the consumption tax rate (3% from 1989; 5% from 1997; 8% from 2014; and 10% from 2019, with a reduced tax rate of 8%). Overall, the CPI has majorly continued to exceed 3% in 2023. If inflation without wage increases continues, it would hurt mortgage borrowers' ability to repay loans.

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6) Household economy

According to a family income and expenditure survey for the three-month period ended June 30, 2023, by the Ministry of Internal Affairs and Communications, annual household income increased moderately with the age of householder and decreased at and after the age of 60 when the householder retires. Savings amounts rose in each age group; it increased to ¥3.42 million for people in their 20s, to ¥8.26 million for those in their 30s, and ¥24.7 million for those in their 60s. Conversely, outstanding debt increased significantly for people in their 20s and 30s, and began to decline for people aged 40 and above. Because most of the debt is for housing and land, the following can be seen in many households.

• When purchasing a house, the age of householders is often in their 30s.
• The amount borrowed at the time of the mortgage contract considerably exceeds the amount of annual income and savings.
• Mortgage repayments decrease for people in their 40s and above, as shown by lower debt and higher annual income and savings.
• Savings amount far exceeds debt and more households pay off their mortgages at and after age 50.

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Development Of Japan's RMBS Market

Japan's RMBS market can be classified into two categories: JHF RMBS and private sector RMBS issued by private financial institutions. As discussed in the section, "Size of the mortgage loan market and main lending institutions," the annual issuance amount of RMBS in Japan peaked at about ¥3.6 trillion in 2016, although the country's outstanding housing loans have been increasing. We think there are two reasons for this. Refinance mortgages included in RMBS have decreased because the demand for mortgage refinancing driven by the introduction of negative interest rates in 2016 has run its course. And full-term fixed rate loans, which are major underlying assets of RMBS, have been decreasing in line with growing proportion of floating-rate loans in new loans.

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JHF RMBS have a distinctive structure. They are issued as straight bonds of JHF at the time of issuance. If a beneficiary certificate trigger event occurs, the bonds are extinguished, and investors acquire trust beneficiary rights in place of the bonds. JHF RMBS employ a pro rata payment structure prior to the occurrence of the beneficiary certificate trigger event and this will convert to a sequential pay structure following the event. Private sector RMBS mostly employ trust schemes. They adopt a senior-subordinate structure, and generally take a sequential pay structure, in which subordinated beneficiary rights are not redeemed until the senior beneficiary rights are redeemed.

Related Criteria

• Global Methodology And Assumptions: Assessing Pools Of Residential Loans, Jan. 25, 2019

Related Research

• Japan Structured Finance Outlook: Inflation Entrenches? Jan. 11, 2024
• Japan Private-Sector RMBS Performance Watch: Low Unemployment Supports Stability, Nov. 7, 2023
• JHF RMBS Performance Watch November 2023: Prepayments Down, Interest Rates Up, Nov. 6, 2023
• Japan Securitization In 2023's First Half: ABS Supports, July 31, 2023
• How Will COVID-19 Affect Japanese Structured Finance? Apr. 8, 2020