"Borrowers' Ability to Cope Plummets with 20% Real Estate Drop"... High-Income Shockwave

Bank of Korea Financial Stability Report
Household Interest Balance Deficit Increases by 502,000 KRW per 0.5%P Interest Rate Hike
DSR Regulation Requires Differential Application by Income Level

[Asia Economy Reporter Seo So-jeong] Concerns have been raised that if housing prices fall by 20% due to the impact of interest rate hikes, borrowers' ability to respond could sharply decline. In particular, the scale of households' net debt (debt that cannot be repaid even if all assets are sold to repay debt) is expected to expand significantly, especially among high-income households.

On the 22nd, the Bank of Korea stated in its "Financial Stability Report" that "As households have expanded mainly real assets rather than financial assets through debt expansion, there is a possibility that households' ability to respond to debt through asset liquidation and interest income and expenses may deteriorate when economic conditions change in the future."

According to the report, in a situation where debt has accumulated, if stock prices fall and the prices of real assets, which account for most (86%) of household assets, rapidly adjust, there is concern that the ability to respond to debt through assets will deteriorate across all income groups.

Assuming that real estate prices fall by 20% from the level at the end of June this year, the average total asset-to-debt ratio and net asset-to-debt ratio of households holding financial debt dropped significantly from 4.5 times and 3.5 times as of June to 3.7 times and 2.7 times, respectively.

The Bank of Korea explained, "The 20% decline rate assumes a situation where real estate prices return to the level before the COVID-19 period, during which apartment prices rose by about 20%, and stock prices undergo a downward adjustment."

While the increase in high-risk households that find it difficult to repay debt through asset sales is expected to be limited across all groups, the scale of net debt among these households is analyzed to expand significantly, especially among high-income households.

When real estate prices adjust by 20%, the proportion of high-risk households rises from 3.2 percentage points to 4.3 percentage points, and the net debt scale of high-risk households increases by 1.9 times in the fifth income quintile (top 20%). The explanation is that the larger the decline in real estate prices, the more the net debt scale of high-income, high-risk households with large debt increases.

Additionally, if interest rates rise, the interest income and expense balance (interest income minus interest expenses) of low-income groups is expected to deteriorate significantly. It is estimated that with a 0.5 percentage point increase in interest rates, the annual interest income and expense deficit per household will increase by an average of 502,000 KRW (from -5.54 million KRW to -6.04 million KRW).

The Bank of Korea pointed out, "For the first income quintile (bottom 20%) low-income group, the interest income and expense deficit ratio relative to disposable income is already below -20%, and if interest rates rise, this ratio could worsen to -22.9%, compared to other households."

It added, "While gradually inducing household debt deleveraging, it is necessary to expand policy incentives to develop financial products that guarantee stable returns to alleviate the concentration of real assets in asset portfolios. Also, to mitigate the problem where differences in debt procurement scale among income groups deepen wealth disparities, the option of applying the Debt Service Ratio (DSR) regulation differentially should be considered."

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