Mortgage prepayment (kuriage hensai) comes in two main forms: the period-shortening type, which shortens your repayment term, and the repayment-reduction type, which lowers your monthly payment. Here's an overview of how each works and how to choose between them.
- Mortgage prepayment (kuriage hensai) is a way of using a lump sum of funds to pay down part or all of your loan principal ahead of schedule.
- The period-shortening type (kikan tanshuku-gata) keeps your monthly payment the same while shortening the repayment term, and tends to produce a larger reduction in total interest paid.
- The repayment-reduction type (hensaigaku keigen-gata) keeps the repayment term the same while lowering your monthly payment, easing your month-to-month burden.
- Whether a fee applies, how much it is, and the minimum amount you can prepay all vary by financial institution, so it's important to check in advance.
- While you're using the home loan tax credit (jūtaku rōn kōjo), prepaying reduces your outstanding balance, which can affect the size of the credit.
Conclusion: If Reducing Interest Is Your Priority, Choose the Period-Shortening Type
If your priority is minimizing total interest paid through prepayment, the period-shortening type generally tends to produce a larger reduction. If you'd rather create more breathing room in your monthly budget, the repayment-reduction type is a better fit. Neither is inherently the "right" choice — the basic idea is to choose based on your purpose for prepaying.
How the Period-Shortening Type Works
With the period-shortening type, your monthly payment stays the same, and the repayment term shortens by an amount corresponding to the prepayment. Paying down the same amount of principal ahead of schedule shortens the term, which reduces the interest you would otherwise have paid in the future — so a larger reduction in total repayment can be expected. This suits needs where you specifically want to shorten the loan term itself, such as wanting to pay off the loan before retirement. Bringing your repayment finish line closer also makes it easier to plan your retirement finances.
How the Repayment-Reduction Type Works
With the repayment-reduction type, the repayment term stays the same, and your monthly payment decreases by an amount corresponding to the prepayment. The reduction in total interest tends to be smaller than with the period-shortening type, but it suits situations where you want to lower your monthly repayment burden in preparation for rising future expenses, such as growing education costs.
Checking Fees and Minimum Amounts
Prepayment may come with a fee, depending on the financial institution. Some institutions charge nothing for online procedures but charge a fee for in-branch procedures, and the minimum amount you can prepay also varies. Before going ahead, you'll need to check the conditions set by your own lender. Handling can also differ depending on the program — for example, Flat 35 — so it's reassuring to review the terms of your specific loan as well.
The Impact on the Home Loan Tax Credit
The home loan tax credit is calculated based on your outstanding balance as of year-end, so if prepayment significantly reduces that balance, it can affect the size of the credit. If you're considering prepayment during the credit period, it's important to weigh the benefit you'd receive from the credit against the interest savings from prepaying. We cover the basics of the home loan tax credit in a separate article, The Basics of the Home Loan Tax Credit — How It Works and How to Apply.
Balancing Prepayment Against Your Cash Reserves
Prepayment also reduces your cash on hand. It's generally considered advisable to secure funds for future needs like education and medical costs, as well as an emergency reserve in case of a sudden drop in income, before considering prepayment with whatever funds remain. Rather than putting a large amount toward prepayment all at once, another approach is to make several smaller prepayments over time as your life circumstances change.
Frequently Asked Questions
Which prepayment method is more cost-effective?
If you prioritize reducing total interest, the period-shortening type tends to be more advantageous; if you want to lower your monthly burden, the repayment-reduction type is a better fit. The basic approach is to choose based on your purpose.
Are there fees for prepayment?
It varies by financial institution. Some charge nothing for online procedures but charge a fee for in-branch procedures, so please check the conditions with your own lender in advance.
Should I avoid prepaying while I'm receiving the home loan tax credit?
It's not a one-size-fits-all answer. It's important to weigh the benefit of the credit against the interest savings from prepaying, and to factor in how much cash you have to spare, before deciding.
Summary
Mortgage prepayment comes in the period-shortening and repayment-reduction types, each with different effects. Taking fees, the impact on the home loan tax credit, and your cash reserves into account, choose the method that fits your own repayment plan.