[1mm Financial Talk] "The Reward of Fixed Interest Rates, The Counterattack of Variable Interest Rates"

[Image source=Yonhap News]

[Asia Economy Reporter Sim Nayoung] "These days, when I say 2% interest rate, everyone is envious." Hwang Seokjun (41, pseudonym), who lives in Suwon, Gyeonggi-do, said there is a reason he can smile despite the historic interest rate hikes. Hwang purchased the apartment he currently lives in December 2019. At that time, he borrowed 500 million KRW and recalled that he struggled a lot over whether to choose a fixed or variable interest rate.

Back then, during a period of falling interest rates, the fixed interest rate (2.82%) was lower than the variable interest rate (3.08%) when Hwang borrowed 500 million KRW, which is the exact opposite of the current situation. "At that time, I thought the interest rates were very low, and since the variable rate didn't seem likely to drop further, I chose the fixed rate. Although I regretted it when the variable rate kept falling until the first half of last year, now that we are in a period of rising interest rates, it was truly a good choice."

Hwang’s monthly interest cost based on the fixed rate is 1,175,000 KRW. If he had chosen the variable rate when buying the house, he would now be paying 250,000 KRW more in interest every month. "The Bank of Korea said it would raise the base rate by 1 percentage point by December this year, and if I had chosen the variable rate then... just thinking about it is dizzying. Even though I have a large loan, I am not too worried thanks to the fixed interest rate."

According to the five major banks (KB Kookmin, Shinhan, Hana, Woori, NH Nonghyup) as of the previous day, the variable interest rates for mortgage loans ranged from 3.56% to 5.82%, and fixed rates ranged from 4.67% to 6.46%. The proportion of variable interest rate loans among domestic household loans reached the highest level in 8 years and 1 month, because during the interest rate hike period, variable rates are about 1 percentage point lower than fixed rates.

According to the Bank of Korea’s Economic Statistics System, the proportion of variable interest rates among household loan balances at deposit banks (as of April) was 77.3%, the highest since March 2014 (78.6%). If the Bank of Korea takes a big step to raise the base rate by 0.5 percentage points in July, variable interest rate household loans will have to absorb the shock of the rate hike directly, which is problematic.

Why does the difference between variable and fixed interest rates occur? A representative from a commercial bank explained, "Variable rates reflect the COFIX rate, which changes monthly, while fixed rates reflect the 5-year financial bond rate, which changes daily, to calculate bank loan interest rates. During periods when the base rate fluctuates, financial bond rates respond faster than COFIX, so during a base rate decline, fixed rates are cheaper, and during a rise, fixed rates are more expensive."

These days, although variable rates seem cheaper immediately, banks say fixed rates are advantageous when looking one year ahead. This becomes clearer when calculated. For example, someone who borrowed 500 million KRW last June choosing the variable rate (2.47%), which was lower than the fixed rate (3.48%), initially paid 1,029,167 KRW in interest, lower than the fixed rate’s 1,450,000 KRW. However, after one year, the variable rate rose to 3.63%, making the interest 1,512,500 KRW. The fixed rate remains the same at 1,450,000 KRW both last year and now. This means many 'interest poor' borrowers could emerge due to the sharp increase in interest burden.

Bank of Korea Governor Lee Chang-yong’s concern about the high proportion of variable rate loans is for this reason. On the 21st, regarding the possibility of a big step in July, Governor Lee said, "A big step is not decided by inflation alone. We must also consider the impact on our economy and exchange rate when inflation rises. Moreover, since Korea has many variable rate bonds, we need to comprehensively consider household interest burdens and create an appropriate combination with Monetary Policy Committee members."

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