[Practical Finance] Immediate Profit or Future Gain... Should You Refinance Your Mortgage Interest Rate?

Rising Financial Bonds Drive Fixed Interest Rates Up Sharply
BOK Indicates Possible Rate Hike Within the Year
Risks of Variable Rate Products Increasing

[Asia Economy Reporter Park Sun-mi] Kim Shin-young (40), who plans to purchase a 900 million KRW apartment in Seoul with a 200 million KRW mortgage loan, is torn between fixed-rate (hybrid) and variable-rate options. When setting the loan term to 30 years with principal and interest installment repayment, the interest rates applied by the five major commercial banks?KB Kookmin, Shinhan, Hana, Woori, and NH Nonghyup?are on average 3.1?3.3% for fixed-rate and 2.5?2.8% for variable-rate, with the variable-rate being lower. Choosing the fixed-rate results in a monthly principal and interest repayment of about 850,000 to 880,000 KRW, while the variable-rate option lowers it to around 790,000 to 820,000 KRW. However, with the Bank of Korea hinting at a base rate hike within the year, Kim is increasingly concerned about the risks associated with the variable-rate, which is more sensitive to interest rate fluctuations, versus the relatively stable fixed-rate.

There are two main types of mortgage loan interest rates. One is the variable-rate product, where the interest rate changes relatively frequently, and the other is the fixed-rate product, where a stable interest rate is applied over a longer period. Variable-rate products fluctuate according to the bank’s funding costs from market deposits, bonds, and other sources. Therefore, variable-rate loans are preferred during periods of declining interest rates.

According to the Financial Supervisory Service’s Financial Consumer Information Portal Fine as of the 2nd, current mortgage loan interest rates at banks show variable rates about 0.5 percentage points lower than fixed rates. Variable-rate mortgage products include KB Kookmin Bank’s ‘KB Mortgage Loan Variable’ at 2.44?3.64%, Shinhan Bank’s ‘Shinhan Housing Loan (Apartment)’ at 2.62?3.62%, Hana Bank’s ‘Hana Variable Rate Mortgage Loan’ at 2.52?3.82%, Woori Bank’s ‘Woori Apartment Loan’ at 2.7?3.52%, and Nonghyup Bank’s ‘NH Mortgage Loan’ at 2.61?3.81%. For fixed-rate mortgage loans, excluding Nonghyup Bank which does not offer such products, there are KB’s ‘KB Mortgage Loan Hybrid’ at 2.87?4.37%, Shinhan’s ‘Shinhan Housing Loan’ at 3.44?4.44%, Hana’s ‘Hana Hybrid Rate Mortgage Loan’ at 3.04?4.34%, and Woori’s ‘Woori Apartment Loan’ at 3.26?4.36%.

Looking only at current interest rates, variable-rate products have a lower interest rate, resulting in a smaller monthly principal and interest burden. This is because fixed-rate products, which set rates based on financial bonds reflecting expected inflation (price pressures), have rapidly increased in rate. A year ago, fixed-rate mortgage loans at the five major banks ranged from 2.31% to 4.11%, which was actually lower than variable rates at 2.33% to 4.16%. Over the past year, as rates have steadily risen, the gap between variable and fixed mortgage rates has widened.

Speculation on Base Rate Hike 'Circulates'... Does Variable Rate Risk Increase?

The issue lies in the possibility of a base rate hike within the year and the potential acceleration of loan interest rate increases at banks, which heightens the risk of variable-rate products. During periods of rising base rates, fixed-rate products are more advantageous than variable-rate ones. This is why consumers face a dilemma when choosing between variable and fixed mortgage loan products.

Experts emphasize that the already highest-in-15-months bank household loan (mortgage and credit loans) interest rates are likely to rise further as bond yields show signs of volatility.

In the bond market, the 10-year government bond yield stood at 2.179% at the end of May, marking the highest level since November 22, 2018 (2.206%). The 5-year yield also rose to 1.739%, the highest in two years. The 20-year and 30-year yields increased to 2.294% and 2.292%, respectively. Bank of Korea Governor Lee Ju-yeol’s statement on May 27 after the Monetary Policy Committee meeting that the possibility of a rate hike within the year depends on economic conditions is closely linked to the Bank’s upward revision of this year’s growth forecast. More than half of all borrowers could be exposed to increased repayment burdens due to rising rates, making a rate hike decision difficult. However, despite the burden of an additional 11.8 trillion KRW in household loan interest when rates rise by 1 percentage point, the financial industry generally agrees that preparations for a rate hike are necessary as the economy improves.

Senior Research Fellow Park Sung-wook of the Korea Institute of Finance analyzed, "Despite the government’s strong measures, the continued rise in housing prices and a 9.5% year-on-year increase in household credit in Q1 this year?higher than income and economic growth?are rooted in ultra-low interest rates that have provided conditions for expanding debt based on low borrowing costs to seek higher returns." He added, "If the current economic recovery continues, it is necessary to begin a gradual increase in the base rate in the second half of the year to orderly adjust the degree of monetary policy easing in line with the extent of economic improvement."