Gov’t tackles debt with 3% interest rate spread

Household debt, including credit card spending, amounts to 1,400 trillion won (1.32 trillion dollars) in Korea, a major burden on the country’s economy. The debt level is so severe that the central bank has held back from raising the nation’s interest rate with the U.S. Federal Reserve’s interest hike.

As a result the government has come up with measures to ease the burden on loan payments to cushion the impact of higher interest rates when the central bank starts raising the key rate.

The measure, announced by the Financial Services Commission, the Financial Supervisory Service and the Credit Counseling and Recovery Service, applies a unilateral interest rate spread of 3 percentage points at banks starting in April. Nonbanking financial companies such as savings banks, brokerage firms and credit card companies will apply the new spread in May.

This is a drop from the spread that is currently applied at financial companies.

When a lender is late in their payment, banks currently add a spread on top of the loan interest rate. However, there have been complaints that the spread that financial institutions have imposed is high and in fact triples the burden from the initial loan interest payment.

On average a 5 to 6 percentage point spread is added to an interest rate when the loan interest payment is late for less than a month. That figure rises to 5 to 7 percentage points within three months and between 6 and 8 percent when exceeding three months.

In the case of savings banks, the spread is higher and can go up to as much as 25 percentage points. Insurers add as much as 11 percentage points.

“In the case of the spread on overdue payments, it has the characteristic of a penalty imposed on lenders with overdue payments rather than as compensation for the burden that these financial institutions bear,” said Lee Ju-hyung, an FTC official.

In other words, it wouldn’t be a loss for the financial companies even if the spread is lowered.

The idea to lower the spread down to 3 percentage points comes from analysis by the state-run Korea Development Institute (KDI).

According to the KDI, the cost of overdue payments is already reflected on the loan’s interest rates when signing the contract. The extra costs are limited. The KDI project that bringing the spread down to 3 percentage points will help without having to impose an additional burden on the financial companies.

In other countries like the United States, United Kingdom and France, the spread on overdue loans does not exceed 5 percentage points.

The government is also easing up conditions in order to increase the possibility of people paying their loan interest in time.

The government has made it possible for those that are in a dire situation to return the principle loan without hurry.

The target is those that own a single apartment with a value less than 600 million won; those that don’t own an apartment but have taken out a loan that is less than 100 million won as well as those that have borrowed less than 400 million won from financial companies to pay for their long-term rent deposit, known as jeonse.

If a lender can provide evidence of their situation such as completely closing down or suspending their businesses, being laid off, the victim of a natural disaster or suffering from health problems that make it difficult for them to return their loans, the government could postpone the deadline on the principle loan payment for a maximum of three years, on two occasions.

But the government is also creating a system that could prevent those that try to manipulate the system by denying help to people that have received huge insurance payments due to illness or have received a large inheriting.

The financial companies have their own programs for such clients, but the terms are different and not many consumers are aware of the program.

“The excessive late payment burden goes beyond the tragedy of an individual to a problem that we all need to work together as a society on as it even hurts a family,” said FSC Chairman Choi Jong-ku. “Financial companies that make profit through a client’s money should not ignore the tears of its clients.”

Yonsei University economics professor Sung Tae-yoon said the lowering of the overdue loan interest spread will also contribute to improving business practices

“Financial companies have been reluctant in managing loans as they enjoy getting a higher spread but with this opportunity, their past practices are likely to change,” the professor said.

BY KO RAN [lee.hojeong@joongang.co.kr]