[Practical Finance] Interest Rates Rise and Limits Decrease... Stricter Loans

Conditions for mortgage loans at commercial banks are becoming stricter. While loan interest rates, which had been steadily declining, have recently rebounded slightly amid government efforts to reduce household debt, loan limits are also decreasing more significantly over time as the 'Stress Debt Service Ratio (DSR)' system is fully implemented.

Loan Interest Rates, Which Had Been Falling, Rebound Slightly

According to the financial sector on the 28th, the variable interest rate mortgage loans at the five major commercial banks (KB Kookmin, Shinhan, Hana, Woori, NH Nonghyup) were recorded at 4.12?7.03%, and mixed (fixed) mortgage loan rates were 3.28?5.81% as of the previous day.

Until the end of last month, variable mortgage loan rates were at 4.00?6.08% per annum, and mixed mortgage loan rates were at 3.22?5.33% per annum. During this period, the Cost of Funds Index (COFIX) fell for two consecutive months to 3.66%, but loan interest rates instead showed an upward trend.

The reasons for the rise in mortgage loan interest rates in the banking sector include the delayed interest rate cuts by the U.S. Federal Reserve (Fed) and interest rate hikes by individual banks. Following KB Kookmin Bank’s 0.23 percentage point increase in the margin rate applied to mortgage loans on the 7th, Shinhan Bank also raised mortgage and jeonse (key money deposit) loan rates by 0.05?0.20 percentage points on the 23rd. Woori Bank will also increase mortgage and jeonse loan rates by 0.10?0.30 percentage points depending on the product starting from the same day.

Commercial banks are ceasing competition to lower loan interest rates and gradually joining the ranks of rate hikes in response to the government’s efforts to stabilize household debt. The government has set a policy to manage household debt growth within the nominal growth rate starting this year to stabilize household debt, which has exceeded 100% of GDP. The government’s nominal growth target for this year is 4.9%. Major financial holding companies have also set goals to manage household loan growth rates within the range of 1.5?2.0% this year in response.

However, according to the Bank of Korea, mortgage loans in the banking sector increased by 4.9 trillion KRW in January alone, marking the second-highest growth since January 2021. This is why banks are joining the trend of raising loan interest rates. A representative from a commercial bank explained, "Even a slight increase in interest rates can significantly curb the growth of household loans," adding, "Some loan product interest rates were raised to ensure stable management of household debt."

Implementation of Stress DSR... Gradual Reduction of Loan Limits

Along with the trend of rising interest rates, loan limit regulations are also tightening. This is due to the Stress DSR system, which came into effect on the 26th. Stress DSR is a system that applies an additional margin rate (stress rate) when calculating the DSR to account for the possibility that borrowers using variable interest rate loans may face increased principal and interest repayment burdens due to rising interest rates during the loan period.

The Stress DSR was introduced to stabilize household debt. Previously, loan limits were calculated based on the interest rate at the time of loan issuance, which often resulted in borrowers bearing excessive interest burdens during periods of rapid rate hikes. An official from the authorities said, "Stress DSR means reflecting future interest rate risks of financial consumers at the time of loan issuance," adding, "It will serve as an opportunity to establish a loan practice where borrowing is within the borrower’s repayment capacity."

The stress rate is determined by comparing the highest monthly weighted average interest rate on household loans over the past five years (as announced by the Bank of Korea) with the current interest rate, while setting upper and lower limits (3.0% and 1.5%, respectively) to compensate for over- or underestimation during periods of interest rate fluctuations. The stress rate is applied gradually. To minimize market shocks, 25% of the stress rate will be applied until June 30, 50% in the second half of the year, and 100% from next year onward.

The stress rate for the first half of this year is 0.38%. Since the difference between the highest weighted average interest rate on new household loans at deposit banks over the past five years (5.64%) and the current rate (4.82%) is 0.82%, the lower limit of 1.5% is applied, and the first half’s weighting (25%) is reflected accordingly.

Due to the application of the stress rate, loan limits will be reduced by up to about 4% in the first half of this year and up to about 9% in the second half. For example, a borrower with an annual income of 50 million KRW taking out a variable interest rate loan with a 30-year maturity and principal and interest installment repayment conditions previously had a loan limit of 330 million KRW, but now the limit is reduced by about 15 million KRW (approximately 4%) to 315 million KRW.

In the second half of the year, when 50% of the stress rate is applied, the loan limit under the same conditions will be 300 million KRW, reduced by 30 million KRW (about 9%) compared to before. From next year, when 100% is applied, the limit will be reduced even more noticeably. For a borrower taking out a variable interest rate loan under the same conditions in the second half of next year, the loan limit will be 280 million KRW, which is 50 million KRW (about 16%) less than before.

A financial sector official said, "It is true that both loan interest rates and limits have become tighter compared to before due to household debt stabilization policies," adding, "Considering that the additional margin rate under the Stress DSR will gradually increase and loan limits may continue to shrink, as well as the delayed timing of the Fed’s base rate cuts, it is necessary to plan loans carefully."