Fixed-rate borrowers feel fooled

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Fixed-rate borrowers feel fooled

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The financial industry was surprised when the central bank unexpectedly shaved 0.25 percentage point off of the benchmark rate earlier this month, the first time the rate had been cut in over three years.

But borrowers who recently took out fixed-rate loans were left stunned and in some cases are scathing, with some claiming they felt betrayed as the central bank has created an environment where it is advantageous to borrow loans at variable rates.

“I took out a 200-million-won [$174,000] loan in February on a fixed-rate basis as the bank told me that the government would be raising the benchmark rate later this year, and that if it did, the move would prove to be a burden if I was on a variable rate,” said a 40-year-old lender. “After hearing the news, all I could think of is the additional money I could have saved if I took the loan out on a variable rate.”

The mixed messages seemingly sent by the government, which has been promoting fixed-rate loans, and the central bank has left loan seekers confused, and further tarnished the credibility of the Bank of Korea and government agencies such as the financial regulators.

The BOK’s sudden move came at a time when commercial banks, pushed by the financial regulators, have been aggressively expanding the number of fixed-rate mortgages authorized over the last 12 months or so.

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The Financial Supervisory Service (FSS), which is concerned by growing household debt, mapped out a comprehensive measure to have fixed-rate mortgages account for 30 percent of the total by 2016.

At present, 87 percent of the 456 -trillion-won household loans borrowed from commercial banks are based on variable rates.

In contrast, some 1.3 million people have taken out loans with fixed rates. This represents less than 15 percent of the 9.5 million people who have taken out loans.

However, fixed-rate loans have been rapidly growing in recent months as commercial banks have been aggressively marketing such loan products to customers.

Fresh household loans with fixed rates only made up 11 percent of all new loans in May 2011. This ratio had jumped to 44 percent this May. After the BOK’s announcement on cutting the rate, the ratio of fresh loans on fixed-rates in June slightly fell to 41 percent.

According to the FSS, a 0.25-percentage-point drop in the benchmark rate should add 1 trillion won to total household debt within the space of a year.

The interest rate on certificates of deposit (CD) that is used to set the rate for mortgages plunged immediately from 3.54 percent to 3.33 percent on July 12, just a few hours after the BOK announced the decision.

This means that someone who has borrowed 100 million won on a variable rate would save 250,000 won in terms of their annual interest payments. Fixed-rate borrowers would not enjoy this benefit, however.

On average, the interest rate on fixed-rate mortgages works out to be 0.2 percentage point higher than when a variable-rate loan is taken out. Market observers say the recent cut could widen the gap between the two by up to 1 percentage point.

“The government’s plan to promote fixed rates for loans is sound,” said Lee Chang-seon, an analyst at LG Economic Research Institute. He said the government, however, ignored the possibility of external and internal factors forcing the benchmark rate to be lowered.

More bad news is likely to cloud fixed-rate borrowers as many market experts expect the central bank to further loosen the monetary policy rates as the global economy is slowing faster than anticipated earlier in the year.

“It seems the central bank has changed its focus by putting less emphasis on economic growth,” said Park Jong-yeon, analyst at Woori Investments & Securities. “For the looser monetary policy to actually take effect, one cut is not enough, however, and we expect the central bank to lower the benchmark rate by 0.25 percentage point on two more occasions this year.”

The central bank, when lowering the benchmark rate for the first time since 2009, said it decided to do so due to the impact of global woes on the domestic economy.

It lowered its economic growth outlook from 3.5 percent to 3 percent recently, lower even than the Ministry of Strategy and Finance’s predicted 3.3 percent.

“The effect of expanding long-term fixed-rate loans will be limited unless the government and the financial regulators first solve a fundamental problem of the loan market,” said Noh Jin-ho, a researcher at Hana Financial Group’s research center. “Most of the mortgages are borrowed for investment purposes rather than for buying a home to live in long-term.”

The BOK’s recent move is expected to have a limited impact on banks. According to a recent report by Credit Suisse, a 0.25 percentage point cut on the benchmark rate only lowers bank’s net profit by an average of 0.02 percent.

The move will rather help improve the bank’s soundness by reducing its corporate and household debt burden, it added.


By Lee Ho-jeong [ojlee82@joongang.co.kr]

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