Despite Rising Loan Interest Rates... Why People Don't Switch from Variable to Fixed Rates

The Bank of Korea's Base Rate Expected to Rise by 1% Point by Year-End, Yet No Movement
Borrowers with Variable-Rate Loans in Low-Interest Era Gain No Benefit Even When Switching to Fixed Rates

Predictions Suggest Limits to Base Rate Hikes Due to Stagflation

[Asia Economy Reporter Sim Nayoung] Although the dominant view within the financial sector is that the Bank of Korea will raise the base interest rate by 1 percentage point (p) by December this year, there is a reason why borrowers with variable-rate mortgage loans remain unmoved. Even though interest rates for those who took out loans with variable rates during the low-interest era have risen since August last year, they are still significantly lower than current fixed rates.

For example, if someone took out a mortgage loan on December 24, 2019, at the lowest variable interest rate of 3.08% offered by a commercial bank, the variable rate has risen to 3.43% as of June 29, 2022. However, this is still more than 1 percentage point lower than the current lowest fixed rate (4.70%) offered by the same bank for refinancing.

Lee Seo-jin (37, pseudonym), who works at a bank branch in Jongno, said on the 29th, "Customers who took out loans with variable rates during the ultra-low interest rate era have no advantage in switching to fixed rates now." He added, "As the base rate rises further, variable rates will also increase, and when the difference between the refinancing fixed rate and the variable rate narrows or fixed rates become cheaper, demand for switching from variable to fixed rates will increase."

Borrowers with variable-rate loans might consider refinancing to fixed rates during a period of rising interest rates, but now is not the right time. If it has been less than three years since the loan was taken out, caution is advised due to early repayment penalties. For mortgage loans, early repayment fees of up to 1.2% apply if refinancing occurs within two years of the loan date. If the early repayment fee exceeds the interest savings from refinancing, it could result in a loss. Since most mortgage loans are in the hundreds of millions of won, early repayment fees can amount to several million won.

The long repayment period of 20 to 30 years for mortgage loans also makes borrowers hesitant to switch to fixed rates. A financial sector official explained, "No one can predict whether the base rate will continue to rise or fall next year. Considering the decades-long repayment period, borrowers with variable-rate loans hesitate to switch prematurely to fixed rates because they might regret it if interest rates fall later."

There are also voices suggesting that 'destructive rate hikes' are unlikely due to concerns about stagflation. Kim Young-jun, a researcher at Hana Financial Management Research Institute, said, "It is uncertain whether major central banks will implement aggressive rate hikes to end inflation and whether political circles will support this." He predicted, "Ultimately, central banks may compromise by accepting some inflation to prevent the economy from falling into recession." Predictions of limits to rate hikes align with the view that the risk of variable rates is not very high.

Nevertheless, those considering switching from variable to fixed rates should first identify the base rate and the spread rate of their current loan product. Loan interest rates consist of 'base rate + spread rate - preferential rate.' Customers using variable rates receive a recalculated loan interest rate based on a new base rate every interest rate adjustment period (usually six months). However, the spread rate remains fixed until maturity.

Therefore, even if the new product's interest rate is lower than the current rate, it is advantageous to compare the spread rates of both loan products and choose the one with the lower spread. During periods of rising rates, the base rate of the current product is often lower than that of the new product, but when the adjustment period arrives, the base rate of the current product will also increase.

A commercial bank official advised, "Early repayment fees and loan limits should also be checked additionally." He added, "When switching loan products, the loan regulations at the time of refinancing application apply. Due to changes in the Debt Service Ratio (DSR) regulations, the loanable amount may decrease, requiring partial repayment before refinancing. Therefore, it is necessary to visit a bank branch for consultation."