[In-Depth Look] The Implications of the Base Interest Rate Hike

Kim Deok-rye, Senior Research Fellow at the Korea Institute of Housing and Urban Research

The Bank of Korea has decided to raise the base interest rate for the first time in 15 months. The base rate, which was 0.5%, has been increased by 0.25 percentage points to 0.75%. What we need to pay attention to is not the short-term impact of the 0.25 percentage point change, but the significance of the fact that the interest rate has passed its bottom and has now entered an upward phase.

The Monetary Policy Committee of the Bank of Korea stated, "Although uncertainties related to COVID-19 continue, the domestic economy is expected to maintain a solid growth trend and inflation is anticipated to remain above 2% for the time being. Therefore, we will gradually adjust the degree of monetary policy easing going forward." This means that unless there are global economic shocks like the past financial crisis or COVID-19, the base interest rate will be raised in the future. Accordingly, various decision-making criteria that operated during the declining interest rate period must now be readjusted to fit the rising interest rate phase.

There is an investment theory that can be helpful in such times. It is the very famous 'Egg Model' by Andr? Kostolany. Andr? Kostolany was a Hungarian investment genius. According to the 'Egg Model,' it is now gradually the right time to sell real estate. The theory suggests that as the interest rate approaches its bottom, one should buy (invest in) real estate, and after passing the bottom, start selling real estate. When the interest rate is rising, investors tend to prefer stocks and bank deposits over real estate. This implies that commercial properties or income-generating real estate may become less favorable.

Until now, people have purchased homes using as much loans as possible in a low-interest-rate environment. As a result, household credit reached 1,806 trillion won as of the second quarter of this year, with household loans at 1,705 trillion won and mortgage loans at 948 trillion won. This is an all-time high. We were worried about household credit reaching 1,000 trillion won, but mortgage loans alone are approaching that figure. Since the loan scale has become enormous, we need to examine the social impact of increased interest burdens due to the interest rate hike. Even if it is not a big problem personally, it is a significant risk factor at the national level.

People who became anxious due to excessively rising house prices have tried to purchase homes using as much loans as possible. Until now, interest rates were at historic lows, so the burden of loan interest was not significant. However, the situation is changing from now on. Those who do not have long-term fixed-rate loans need to consider the increased interest burden due to variable interest rates. There is also discussion about additional interest rate hikes within the year. Although not certain, the timing may be delayed but the rate will inevitably adjust to the 1% range soon. Mortgage loan interest rates have already surpassed the 2% range and will gradually rise further. Preparation is necessary. For existing loans, those with variable interest rates should consider switching to fixed-rate loans to minimize the increase in loan interest burden. Even for fixed-rate loans, it is important to review the bank’s spread structure to minimize interest costs.

If the interest to be paid increases on a fixed income, disposable income decreases. The more vulnerable housing groups may find it difficult to bear loan interest. The government should closely monitor the financial status of such households. Those who purchased homes using loans should calmly assess whether they can handle the increasing interest. Also, those planning to buy homes with loans should carefully evaluate whether they can manage future loan interest burdens before making housing purchase decisions. Owning a home is important. However, since the interest rate environment is changing, it is necessary to redesign the strategies prepared so far to adapt to the changing environment.

This content was produced with the assistance of AI translation services.