Bought a House with Yeongkkeul Loans and Debt Investment... Alarming Rise in Market Interest Rates

4 Major Banks' Personal Loan Interest Rates in February at 2.59~3.65% Annually... Up 0.6%p in 6 Months
Market Rate Increase Affects Base Rate... Economic Crisis Risk and Careful Management Needed

Borrowers Facing Urgent Pressure

[Asia Economy Reporters Kwangho Lee, Seungseop Song] Office worker Choi Seon-gyu (46, pseudonym) took out a variable-rate mortgage loan of 300 million KRW from Bank A at an interest rate of 2.5% earlier this year when he moved. Choi chose the variable rate because it is generally 0.2 to 0.3 percentage points lower than the fixed rate, but with recent rate hikes, his interest burden has increased. Even a 0.5 percentage point rise in the base interest rate would increase his annual interest payment from 7.5 million KRW to 9 million KRW, a 1.5 million KRW increase.

As bank loan interest rates have steadily risen this year, the interest burden is increasing not only for those who invest with borrowed money (debt investment) or those who have pulled together all their resources (Yeongkkeul) but also for ordinary citizens. The rise in market interest rates due to inflation expectations and government measures to curb household loan growth have combined to signal a warning for investments made through bank loans. With the COVID-19 situation expected to ease in the second half of the year and consumption recovering, the base interest rate is likely to rise. If stock and housing price volatility increases, it could trigger a crisis across the entire financial market. Experts advise that interest rate pressure during economic normalization is inevitable and that exit strategies for vulnerable groups must be prepared.

◆Record-High Household Loans... Increasing Interest Burden on Ordinary Citizens= According to the Bank of Korea, household debt from financial institutions reached 125.8 trillion KRW last year. Considering that household credit increased by 63.6 trillion KRW in 2019, household debt nearly doubled compared to the previous year. The annual growth rate was 7.9%, the highest since 2017 (8.1%). This surge is due to the boom in debt investment and Yeongkkeul, where many people borrowed to invest in stocks and real estate. The problem is that the total amount of debt to be repaid increases as household debt, which surged under low interest rates, faces rising loan interest rates.

As of the end of last month, the credit loan interest rates (grade 1) at the four major banks?KB Kookmin, Shinhan, Hana, and Woori?ranged from 2.59% to 3.65% annually. Compared to the end of July last year when 1% range credit loan rates applied (1.99% to 3.51%), the lower bound has risen by 0.6 percentage points. The mortgage loan interest rates (linked to COFIX) at the four major banks also increased by 0.09 percentage points (lower bound) to 2.34%?3.95% annually during the same period. This is attributed to the combined effect of rising market interest rates and reduced preferential rates due to financial authorities' pressure.

Credit loan interest rates use short-term financial bond rates such as 6-month and 1-year bank bonds as benchmarks. Among these, bank bond rates have been on the rise since the second half of last year. The 1-year bank bond rate (AAA, unsecured) rose from 0.761% at the end of July last year to 0.856% at the end of February, an increase of 0.095 percentage points in six months. Additionally, COFIX, which is linked to variable mortgage rates, has rebounded influenced by market interest rates. If COVID-19 eases in the second half and market interest rates expand, the Bank of Korea is likely to raise the base interest rate. In other words, investors who have taken on excessive debt will inevitably be hit hard. As of the end of last year, the proportion of variable interest rates in bank household loans was 69.4%. Considering the total bank loan balance of 850 trillion KRW, a 0.25 percentage point increase in the base rate would increase the annual interest burden on households by 1.5 trillion KRW.

◆Interest Rate Rise to Accelerate in Second Half... Need for Debt Reduction Measures= Experts point out that the rise in loan interest rates will accelerate in the second half of the year, requiring proactive preparation. If housing prices or stock prices plummet, households that borrowed heavily to buy homes or stocks could face severe shocks. Household debt could exceed a 'manageable' level.

Professor Park Juhyun of Dongduk Women’s University’s Department of Economics predicted, "Once the COVID-19 situation settles, interest rates will rise, potentially leading to an economic crisis." Professor Sung Taeyoon of Yonsei University’s Department of Economics said, "If U.S. Treasury yields rise, upward pressure will also affect Korean Treasury yields, which will sequentially impact bank loan interest rates. Government intervention in interest rates could worsen the situation."

They agreed that special management is necessary as the risk of household loan defaults is higher among vulnerable groups with low income and low credit ratings, who are considered 'weak links.'

Professor Park expressed concern that "vulnerable groups may reach a point where they cannot repay their debts, potentially causing a major crisis in financial markets and the overall economy." Professor Sung also advised, "The government needs to carefully manage so that vulnerable groups do not get pushed into secondary financial institutions such as mutual savings, mutual finance, credit unions, Saemaeul Geumgo, or loan companies."

According to the Bank of Korea, the loan balance in the secondary financial sector was 608.545 trillion KRW at the end of last year, an increase of 65.93 trillion KRW from 543.452 trillion KRW a year earlier. Bank of Korea Governor Lee Ju-yeol warned at a press conference last month, "If market interest rates rise sharply, it will lead to higher loan interest rates, increasing debt burdens especially for vulnerable borrowers and causing greater volatility in asset markets such as stocks."

As household debt grows rapidly, financial authorities are preparing related measures to be announced around mid-month. The core is to apply the Debt Service Ratio (DSR) individually, assessing principal and interest payments against income to lend according to repayment ability. There is also a plan to require monthly repayment of principal and interest on credit loans, which may further increase the interest burden on ordinary citizens.