[Why&Next] Why Is There No '30-Year Fixed-Rate Mortgage' in Korea?

Korea is Different from the US... Short-Term Loan Funding
High Interest Rate Risk Makes Long-Term, Fixed Rates Difficult
Even If Launched, Rates Will Be Higher Than Other Products
Financial Authorities "Stability is Key... Should Focus on Long-Term, Fixed Rates"

On the 14th, amid the ongoing decline in real estate prices and a transaction freeze, apartment listings with price tags are displayed at a real estate-dense shopping area in Songpa-gu, Seoul. Photo by Jinhyung Kang aymsdream@

Variable interest rate or fixed interest rate. Since interest rates began to rise, this has been a dilemma for the entire nation. An employee in charge of mortgage loan services at a commercial bank branch said the selection criteria are surprisingly simple. "People tend to lean toward the side with the lower interest rate right now. Even though there are forecasts of interest rate declines starting next year, 8 out of 10 new borrowers choose fixed interest rates because the current fixed rates are cheaper."

Normally, fixed interest rates are higher when considering interest rate fluctuation risks. But now, the situation is reversed. As of the 7th, the variable interest rates at the five major banks ranged from 4.58% to 7.18%, while fixed rates ranged from 4.21% to 6.47%. This unusual situation is the result of banks deliberately adjusting rates following financial authorities' instructions to increase the proportion of fixed rates. The intention is to reduce the interest rate rise risk for the 'Younggeuljok' (people who borrowed to the limit, even to the extent of their soul). Especially when new household loans are increasing these days, the authorities pay more attention to the fixed-rate proportion. If interest burdens increase, consumption decreases, leading to a decline in economic vitality.

The U.S. and Korea Have Fundamentally Different Bond Market Structures

The fixed interest rates we commonly encounter are structured as fixed for five years, then switching to variable rates. The financial authorities want to go a step further. Their goal is to create 30-year long-term fixed-rate mortgage loan products. The model is based on the U.S. or European style. Opinions clash over this: some say "due to the characteristics of the domestic financial market, decades-long fixed rates are difficult," while others argue "it is possible if banks cooperate."

As of the end of last year, the overall mortgage loan composition in Korea was 56.0% variable rates, 20.9% fixed rates, and 23.1% pure fixed rates. Pure fixed rates, where the interest rate does not change until maturity, exist only in policy mortgages. An example is the Special Bogeumjari Loan operated by the Korea Housing Finance Corporation. In contrast, the U.S. and Europe have a much higher proportion of pure fixed rates because these are mainly products handled by banks. The share of pure fixed rates in mortgage loans (based on the average from the end of 2019 to the end of 2020) was 98.9% in the U.S. and 91.4% in the U.K.

Why are there no such decades-long fixed-rate products in Korea? Fundamentally, the financial market environment is different. For banks to provide loans, they must raise funds by selling deposit products or issuing bonds. In the U.S., when banks issue long-term bonds with maturities over 10 years for mortgage loans, government-sponsored enterprises like Fannie Mae or Freddie Mac absorb them. Korean banks mainly rely on short-term funding. Most bank bonds and deposits have maturities of 1 to 3 years.

"There must be a market where long-term bonds are issued and traded for long-term fixed-rate mortgage loans to emerge. The U.S. has a well-developed direct finance market. The average maturity of bank bonds or corporate bonds is 15 years. If problems arise with long-term fixed-rate bonds, there is even a market that trades junk bonds. In contrast, Korea is centered on indirect finance. Even regular deposits are usually for one year. The average maturity of bank bonds is just over three years. Since funding is short-term, it is impossible to launch 10-year fixed-rate mortgage loans. The interest rate fluctuation risk is too high." (Kim Wanjung, Senior Research Fellow at Hana Financial Management Research Institute)

Even If Long-Term Fixed-Rate Products Are Released, Interest Rates Will Be Much Higher

Even if long-term fixed-rate products are introduced, banks say the interest rates will be much higher than other products. For example, the Special Bogeumjari Loan, which operates with fixed rates for up to 50 years, issues MBS (Mortgage-Backed Securities) to raise loan funds. During periods of rising interest rates like now, the MBS issuance rate is higher than the Special Bogeumjari Loan rate, resulting in losses. However, the government absorbs these losses, allowing policy products to be sold at low rates.

But private banks have no reason to do so. Senior Research Fellow Kim predicted, "If general banks fully reflect maturity management risks, the level of long-term fixed rates will be much higher, making them unpopular." For example, if the variable rate changing every six months is 4% and the 5-year fixed rate is 5%, then the 30-year fixed rate would be at least around 7-8%.

The authorities have requested banks to expand covered bond issuance to increase long-term fixed-rate loans. However, this too faces difficulties. Covered bonds are bonds issued by banks secured by high-quality assets such as mortgage loans. Although they are safe assets, their interest rates are lower than bank bonds and their maturities are long, so there is little demand. A commercial bank official said, "Who would want to raise funds with 30-year bonds during a period of rising interest rates?" and "Since they don't sell, banks have no motivation to issue them."

There are also concerns about the side effects of long-term fixed rates. A representative issue is that it could weaken the effectiveness of monetary policy. "In countries where variable-rate mortgage loans dominate, when interest rates change, the repayment amounts of all borrowers change. Loan interest rates respond sensitively to short-term rates that move according to monetary policy. However, in countries where fixed-rate mortgage loans dominate, only the repayment amounts of new borrowers change when interest rates fluctuate. The overall cash flow impact on borrowers is small. This results in a weakening of monetary policy." (Kwon Heungjin, Research Fellow at Korea Institute of Finance)

As the average loan interest rate in the banking sector has been rising for two consecutive months, a banner displaying mortgage loan interest rates is hung on the exterior wall of a commercial bank in Seoul on the 31st. Photo by Jinhyung Kang aymsdream@

Authorities Say "We Must Provide the Public with the Option of Stable Interest Rates"

Nonetheless, the financial authorities' stance is that the public should be given the right to choose 'stable interest rates' over 'immediately cheap rates.' On the 8th, the Financial Services Commission announced incentives for banks to create long-term fixed-rate loan products. Starting January next year, each bank's fixed-rate loan performance will be reflected in the differentiated evaluation indicators for deposit insurance premiums. Administrative guidance that rewards banks for providing long-term fixed-rate loans will also begin in the first quarter of next year. Benefits for issuing covered bonds, which are funding sources for long-term fixed-rate loans, will also be increased.

Kim Taehoon, head of the macro-finance team at the Financial Services Commission, said, "When the Korea Housing Finance Corporation first issued MBS, people said it wouldn't work, but eventually a market worth tens of trillions was created," adding, "Even if it takes time, banks will issue long-term bonds and build a market base to absorb them." He continued, "Banks already buy each other's bank bonds, so there is a way to operate long-term bonds in that manner," and added, "Once long-term fixed-rate products are introduced and loans are actually made, the public will be able to feel the stability of interest rates."