"These Days, Everyone Envies a 2% Interest Rate"

Reasons for Confidence Despite Historic Interest Rate Hikes
"Thanks to Choosing Fixed Rates... Interest Burden Would Have Been Higher Otherwise"
Variable Rates May Seem Cheaper Now, But Careful Consideration Is Needed Before Choosing

[Asia Economy Reporter Sim Nayoung] Hwang Seok-jun (41, pseudonym), who lives in Suwon, Gyeonggi Province, feels at ease despite the unprecedented interest rate hikes. Hwang purchased his current apartment in December 2019. At that time, he took out a 500 million KRW loan and recalled that he had many concerns about whether to choose a fixed or variable interest rate. Back then, during a period of falling interest rates, the fixed interest rate (2.82%) was lower than the variable interest rate (3.08%), which is the exact opposite of the current situation.

"At that time, I thought interest rates were very low, and since I didn't think variable rates would drop further, I chose the fixed rate. Although I regretted it when variable rates kept falling until the first half of last year, now, during this period of rising rates, I realize it was a very good decision. Nowadays, when I say I have a 2% interest rate, everyone envies me."

Hwang’s monthly interest payment based on the fixed rate is 1,175,000 KRW. If he had chosen a variable rate when buying the house, his monthly interest cost would now be 250,000 KRW higher. "The Bank of Korea said it would raise the base rate by 1 percentage point by December this year. If I had chosen the variable rate then... just thinking about it is terrifying. Even though I have a large loan, I am not too worried thanks to the fixed rate."

According to the five major banks (KB Kookmin, Shinhan, Hana, Woori, NH Nonghyup) as of the 27th of last month, the variable mortgage loan interest rates ranged from 3.56% to 5.82%, while fixed rates ranged from 4.67% to 6.46%. The proportion of variable interest rates in domestic household loans reached the highest level in 8 years and 1 month, mainly because during the interest rate hike period, variable rates are about 1 percentage point lower than fixed rates.

According to the Bank of Korea’s Economic Statistics System, as of April, the proportion of variable interest rates in household loans from deposit banks was 77.3%, the highest since March 2014 (78.6%). If the Bank of Korea takes a big step by raising the base rate by 0.5 percentage points in July, variable rate household loans will have to absorb the full shock of the rate hike, which is problematic.

During times like these, although variable rates seem cheaper immediately, banks say fixed rates are advantageous when looking ahead one year. This becomes clearer when calculating. For example, someone who borrowed 500 million KRW last June choosing the variable rate (2.47%), which was lower than the fixed rate (3.48%), initially paid 1,029,167 KRW in interest, lower than the fixed rate’s 1,450,000 KRW. However, after one year, the variable rate rose to 3.63%, making the interest 1,512,500 KRW. The fixed rate remains the same at 1,450,000 KRW both last year and now. This means many 'interest poor' borrowers could emerge due to the sharp increase in interest burdens.

Why does the difference between variable and fixed rates occur? A representative from a commercial bank explained, "Variable rates reflect the COFIX rate, which changes monthly, while fixed rates reflect the 5-year financial bond rate, which changes daily, to calculate bank loan interest rates. During periods when the base rate fluctuates, financial bond rates respond faster than COFIX, so during a base rate decline, fixed rates are cheaper, and during a rise, fixed rates are more expensive."

This is also why Bank of Korea Governor Lee Chang-yong expressed concern about the high proportion of variable rate loans. On the 21st, regarding the possibility of a big step in July, Governor Lee said, "A big step is not decided solely based on inflation. We must also consider the impact on our economy and exchange rates when inflation rises. Moreover, since Korea has many variable rate bonds, we need to comprehensively consider household interest burdens and work with Monetary Policy Committee members to find an appropriate combination."