What does the Bank of Japan increasing its interest rate from .25% to .5% mean and why is it causing panic in the markets?

Question

I’m no good at economics lol

In: 4812

Answer 1

I’m going to use dollars because I’m not sure of Yen figures, but the principle is the same.

What they’ve done is double the amount of interest payable on a loan. Think of interest as the cost of borrowing money. If I lend you $10 I’ll charge you 10% interest so you’ll have to pay me back $11. That’s my condition for lending you that money.

If you have a home loan, a portion of your repayments is going towards interest. Your loan is for a set term and they calculate your repayments to factor in the interest so that come the end date of your loan term you’re making your final payment.

When interest rates rise, you’re now paying more money on the loan balance, which means higher repayments to ensure the loan is paid off on the final date.

Future market movements aren’t factored into repayments so you pay what the current rate is. You can choose to lock in your interest rate, so if it rises you continue paying the old lower rate. But if you do lock it in and the rate drops instead of rises you’re still paying the old (now higher) rate.

For your specific question a rise from 0.25% to 0.50% sees a doubling of the interest owed on your loan.
So let’s say your repayments are $3500 a month. For the purpose of this example only, $400 of that is covering the interest accrued. By doubling the interest rate, that monthly repayment now rises to $3900. So that household now needs to find $400 extra a month.

If people have taken out loans will within their means, that extra repayment amount should be easy to find in savings, though it might mean some lifestyle adjustments or a reduced savings amount. The problem (and panic) comes from the fact that when people apply for loans they’ll receive a maximum loan amount based on their ability to repay at time of lodgement, and will generally look at homes/places that will cost the full loan amount. So if they’re approved for a million dollars they’ll buy a home worth at or close to a million dollars. Then when rates rise, that loan amount (which was based on their ability to repay at time of lodgement) now becomes beyond their means to repay comfortably so they either need to take money from other areas of their life to maintain payment, or start missing payments and risk defaulting on their loan and losing their loan collateral (the house).