Flood of 'Bittu' Warnings... Will Customized Products for Rising Interest Rate Era Make a Comeback?

Variable Interest Rates Account for 50.3% of Mortgage Loans, 'Half'
Loan Products Tailored for Rising Interest Rates, Previously Overlooked
Regaining Attention Amid Interest Rate Increase Trends

[Asia Economy Reporter Park Sun-mi] Following the Bank of Korea, financial authorities such as the Financial Services Commission and the Financial Supervisory Service have also warned that preparations must be made for the rising interest rate period, showing signs that loan products tailored for the rising interest rate environment, which had been neglected, are making a comeback.

According to the financial sector on the 29th, the principal and interest installment repayment type mortgage loan products of the four major domestic banks?KB Kookmin, Shinhan, Hana, and Woori Bank?form an interest rate range of a minimum of 2.51% to a maximum of 4.01% when applying variable interest rates. Based on current interest rates, if one sets the loan period to 10 years to purchase a 900 million KRW apartment and borrows 200 million KRW, the average monthly repayment amount is about 1.88 to 1.91 million KRW. On the other hand, under the same conditions but applying fixed interest rates, the four major banks’ rates range from a minimum of 2.74% to a maximum of 4.44%, with an average monthly repayment amount of about 1.92 to 1.94 million KRW.

Simply comparing, using variable interest rates results in a lower average monthly repayment amount, but the problem is that we are currently in a rising interest rate period. According to the Korea Financial Investment Association, the 10-year government bond yield rose from 1.71% at the end of last year to 2.01% as of the 26th of this month. During the same period, the 3-year government bond yield increased from 0.98% to 1.12%, and the 5-year government bond yield rose from 1.34% to 1.53%.

Borrowers’ Burden Increases When Using Variable Interest Rate Loan Products in Rising Interest Rate Periods

The average monthly repayment amount is based on the assumption that the average interest rate at the time of loan origination remains constant throughout the loan period. If interest rates continue to rise, borrowers using variable interest rate loan products will face increased principal and interest repayment burdens due to the rising rates. Borrowers using variable interest rate loans currently account for about half of all borrowers. As of the end of last year, the proportion of variable interest rate mortgage loans, including bank-backed jeonse (key money deposit) loans, was 50.3%. This means that more than half of all borrowers are exposed to the risk of increased repayment burdens due to rising interest rates.

Currently, financial authorities are reviewing the operational status and issues of mortgage loans designed to mitigate interest rate risk, which were launched in March 2019 but failed to attract attention. Following the financial authorities’ proposal at that time, 15 banks introduced interest rate cap-type mortgage loans that limit the interest rate increase to a certain level (1 percentage point annually, 2 percentage points over 5 years) even if market interest rates rise, and monthly repayment fixed-type mortgage loans that fix the monthly repayment amount even if the principal repayment amount is reduced. However, these products were unpopular due to the continued low interest rate environment after their launch.

There was no need to hedge interest rate risk by using loans with higher interest rates. In fact, as of the end of last month, the balance of interest rate cap-type mortgage loans was only 6 cases totaling 466 million KRW, rendering them practically ineffective.

In the market, with the recent atmosphere of rising interest rates, there is growing weight to the possibility that tailored products, which had almost disappeared, will be revived if financial authorities encourage the launch of various loan products to prepare for the rising interest rate period.

Recently, Financial Supervisory Service Governor Yoon Seok-heon urged at an executive meeting the need to encourage the launch of various loan products so that borrowers can easily utilize fixed interest rate loans or interest rate cap-type loans to mitigate interest rate risk if they desire. Do Kyu-sang, Vice Chairman of the Financial Services Commission, also stated at a financial risk response team meeting, "We will closely monitor market conditions and proactively manage them in case the U.S. interest rate rise synchronizes with domestic interest rates."