[Issue Analysis] "Monthly Interest Up 300,000 Won in One Year"... Yeongkkeuljok Struggling with Interest Rate Hikes

Borrowers with 400 Million Won Mortgage Loans in 2020
Last Week, COFIX Rose to 1.72%,
Variable Interest Rates Followed to 3.2%
Monthly Interest Up by 300,000 Won Compared to Last Year

BOK Signals Additional Base Rate Hike
Interest Cost Likely to Keep Rising

Concerns Over Rising Delinquency Among Vulnerable Borrowers
If Self-Employed Loan Rates Increase by 1%p,
Interest Burden Estimated to Rise by 6.5 Trillion Won

[Asia Economy Reporter Shim Nayoung] From the 18th, the variable interest rates on mortgage loans at commercial banks will rise significantly. Borrowers who had borrowed money by pulling together every last bit of their resources to buy homes during the ultra-low interest rate era over the past 1-2 years will face increased repayment burdens. The rise in mortgage loan variable interest rates is due to the COFIX (Cost of Funds Index), the benchmark for calculating these rates, jumping from 1.70% in March to 1.72% in April as of the 15th. On the same day, the Bank of Korea raised the base interest rate to 1.50%, making it highly likely that COFIX will rise further in May. This means variable interest rates could increase even more next month.

How Long Will the ‘Interest Rate Fear’ Last?

"At this point, it’s at the level of interest rate fear." Ban Seung-yeon (43, pseudonym), who took out a 400 million KRW mortgage loan from a commercial bank in April 2020 to buy an apartment, is now afraid to even look at her bank account. After COFIX rose last week, the new interest rate applied to her loan as of the 18th is 3.2%. The monthly interest payment has become 1,066,667 KRW. Ban said, "Compared to April last year, my monthly interest alone has increased by 300,000 KRW. Everyone around me kept saying, ‘If you don’t buy a house now, you’ll never be able to,’ so I borrowed beyond my means, but the house prices haven’t gone up as expected, only the interest has increased," expressing her concern.

If Ban had taken out a mixed-rate loan (fixed for 5 years, then variable), her situation might have been somewhat better. If she had chosen the mixed rate (2.9%) two years ago, she would have paid a fixed monthly interest of 966,667 KRW for five years. When she was deciding on the loan, the variable rate (2.74%) was 0.16 percentage points lower than the mixed rate, so she chose it, but the situation has completely changed. The variable rate, which adjusts every six months, has continued to rise and now exceeds the mixed rate by 0.3 percentage points.

Ban is not alone in this situation. According to the Bank of Korea’s data on the proportion of variable and fixed-rate loans, as of February, 78% of new loans were variable rate, while only 22% were fixed rate. A commercial bank official said, "During periods of rising interest rates, variable rates tend to surpass fixed rates in the long term, increasing loan risks," adding, "The delinquency rate among ‘Eonggeuljok’ (those who borrowed to the limit) may also rise."

Ban’s rising interest costs are expected to continue for the time being. Lee Chang-yong, the nominee for Governor of the Bank of Korea, who is awaiting confirmation hearings, hinted at further base rate hikes. In response to a parliamentary question on whether raising interest rates is appropriate, Lee said, "As the economy continues to recover and high inflation is expected to persist for a considerable period, it is desirable to conduct monetary policy with appropriate adjustments to the degree of easing to achieve price stability."

[Image source=Yonhap News]

What Should More Vulnerable Borrowers Do?

The situation is more serious for vulnerable borrowers. According to the Bank of Korea, although the proportion of vulnerable borrowers among household loans has decreased recently, the rise in loan interest rates could increase delinquency rates among these borrowers, thereby increasing risks.

According to the Bank of Korea, at the end of last year, vulnerable borrowers accounted for 6.0% of borrowers and 5.0% of loan balances. These figures had declined from 7.7% and 6.5%, respectively, in the third quarter of 2018. After government support measures were lifted following COVID-19, the proportion of vulnerable borrowers decreased. However, the fact that these vulnerable borrowers are more sensitive to interest rate changes than non-vulnerable borrowers is a risk factor.

The delinquency rate for vulnerable borrowers fell by 1.8 percentage points during the past interest rate decline period (Q2 2019 to Q4 2020) but rose by 1.9 percentage points during the interest rate increase period (Q4 2016 to Q1 2019). The delinquency rate for non-vulnerable borrowers showed little change.

Even when looking specifically at loans to self-employed individuals, debt burdens are increasing in line with the interest rate hike trend. According to data submitted by the Bank of Korea to Jang Hye-young, a member of the Justice Party, if loan interest rates rise by 1.0 percentage point, the interest burden for self-employed borrowers (based on debt balances at the end of last year) is estimated to increase by about 6.4 trillion KRW. As of the end of last year, the total loan balance for self-employed individuals was 909.2 trillion KRW, a 13.2% increase from 803.5 trillion KRW a year earlier.

Professor Sung Tae-yoon of Yonsei University’s Department of Economics said, "Although the interest burden on vulnerable borrowers will increase, if the base rate is not raised gradually now, it will have to be raised sharply later, which would pose greater risks. The government should encourage self-employed borrowers who were granted loan repayment deferrals until September to start repayments quickly if they have the ability to pay, and take measures to write off bad debts for those who cannot repay to minimize shocks."