[Practical Finance] Smart 'Switching' Methods for Loans and Savings During Interest Rate Hikes

BOK Signals 2-3 Interest Rate Hikes This Year
Variable Rate Loan Borrowers Face Higher Interest Burden
Commercial Banks Increase Fixed Rate Refinancing Loans
Need to Review Prepayment Fees and Financial Policies

#1. Mr. A, a man in his 30s living on the outskirts of the Seoul metropolitan area, has been increasingly worried every time he reads articles about recent interest rate hikes. Last year, he took out a variable-rate loan of about 230 million KRW (2.6%, equal principal and interest repayment, 30-year maturity) from a commercial bank for a home purchase. However, last year, the interest rate jumped to the mid-3% range, causing his monthly principal and interest repayment to exceed 1 million KRW. Mr. A is now weighing whether switching to a fixed-rate product with an interest rate difference of more than 1 percentage point would be advantageous or disadvantageous for him.

#2. Ms. A, a woman in her 30s who has been working in Seoul for eight years, is also concerned about how to manage her 100 million KRW fixed deposit that is about to mature. Given the rising interest rate environment, she is considering renewing the fixed deposit, but news that the base rate may be raised two to three times this year has made her hesitant, fearing that opening the account earlier might result in losses.

As the era of significant interest rate hikes begins, more financial consumers are considering switching their loans, savings, and fixed deposits that were maintained during the previous low-interest period. With the U.S. Federal Reserve preparing to raise the base rate by 50 basis points (1bp=0.01%) in a so-called ‘big step’ and the Bank of Korea also forecasting two to three base rate hikes within the year, borrowers are considering switching to fixed-rate loans depending on their situations, and depositors are looking into switching to savings and fixed deposit products offering better interest rates.

Interest Bomb Threatens... Anxious Variable-Rate Borrowers "Should We Switch?"

According to the financial sector on the 14th, the fixed mortgage loan rates (including hybrid types) at the four major domestic commercial banks (KB Kookmin, Shinhan, Hana, Woori) were recorded at 3.90?6.26%. Compared to the variable mortgage loan rates at the same banks on the same day (based on COFIX new contracts, 3.40?5.28%), the upper end is about 0.98 percentage points higher, and the lower end about 0.5 percentage points higher.

Despite this interest rate gap, more borrowers are considering switching to fixed-rate loans (refinancing) because the global trend of interest rate hikes, including in Korea, is accelerating. Due to inflation driven by the COVID-19 pandemic’s accommodative monetary policy and the Ukraine crisis, the U.S. Federal Reserve is preparing a big step to raise the base rate by 0.5 percentage points next month. Accordingly, the Bank of Korea has also announced plans for two to three additional base rate hikes within the year.

When the base rate rises, borrowers with existing variable-rate loans face increased interest repayment burdens. Variable-rate loans are generally calculated by adding a margin to the base rate and then subtracting preferential rates, with the base rate (COFIX) applied every 6 to 12 months. Considering that fixed-rate loans based on financial bonds reflect market rate increases relatively quickly, switching to fixed rates early can reduce interest burdens depending on the situation.

Pay Attention to Prepayment Penalties and Interest Rate Policies... Using ‘Ma-tong’ is Also an Option

Commercial banks are also reopening the door to refinancing loans. KB Kookmin Bank recently resumed ‘conditional refinancing loans,’ allowing customers to refinance mortgage loans taken from other banks into their products via non-face-to-face methods after about six months. Hana Bank has also restarted refinancing for non-face-to-face loan products such as ‘Hana OneQ Apartment Loan.’ So, what basic points should be considered when switching?

First, it is necessary to consider prepayment penalties that may occur during refinancing. Generally, if a loan is terminated before three years from execution, a prepayment penalty of up to about 1.2% is charged. If this penalty exceeds the benefits of refinancing, switching is unnecessary. The ‘limit’ issue should also be considered?whether the desired amount will be fully approved during refinancing. This is due to strengthened regulations related to real estate secured loans, such as the Debt Service Ratio (DSR), over the past three years.

Mr. Oh Kyung-seok, PB team leader at Shinhan Bank’s Shinhan PWM Taepyeongno Center, said, “Countries worldwide are raising base rates due to inflation, and financial institutions have preemptively reflected this volatility, resulting in a difference of about 0.7 percentage points between variable and fixed rates (over 5 years) within the last six months.” He added, “If you have a short-term repayment plan, it might be better to maintain the current variable rate despite the burden, considering new costs after refinancing. However, if you have no long-term repayment plan, refinancing is advantageous.”

Experts advise that if you decide to switch due to no long-term repayment plan, it is important to watch the new government’s financial policy direction. Mr. Oh said, “Currently, it is difficult to gauge the volatility of base rate hikes centered on the U.S., and this uncertainty is reflected in the gap between variable and fixed rates. Rather than refinancing immediately, it is better to wait until after the new government takes office and the Bank of Korea’s rate direction stabilizes somewhat before refinancing.”

For loans scheduled to be repaid within a year and deemed not to require refinancing, using a ‘Ma-inus Tongjang’ (overdraft account) instead of switching can be an option. Considering the interest rate gap between deposits and loans, managing loans flexibly through an overdraft account may be more advantageous than saving funds in deposits for a year to repay loans. Mr. Oh advised, “Even if the interest rate is slightly higher, using an overdraft account for assets scheduled to be repaid within a year can be a method. When funds such as salary flow in, the liquidity debt decreases, which can temporarily reduce debt.”

Meanwhile, although not classified as refinancing, borrowers whose credit situations have improved can consider the ‘right to request an interest rate reduction.’ This right allows consumers who have improved their credit status through employment, promotion, asset increase, or credit score improvement to request a rate reduction from financial institutions. However, the acceptance rate is below 30%. A representative from a commercial bank said, “If you have a short-term loan repayment plan and your income, position, or credit score has improved, actively utilizing this right can be a good method.”

With the start of the interest rate hike period, banks are also releasing high-interest deposit products that can generate stable profits. Customers need to carefully select products that suit their situations. Especially for savings and fixed deposits, short-term products are advantageous in the current environment. As the low-interest era ends and rate hikes are expected across the board, it is better to avoid locking in large sums at relatively low current rates. A representative from a commercial bank advised, “If you deposit a large sum hastily, you may miss the opportunity to join better products. It is necessary to carefully choose considering various preferential rate conditions and opportunity costs.”