"To Prevent Jeonse Accidents, Guarantee Ratios Must Be Reduced and Shifted to Monthly Rent"

Rising Awareness of Jeonse Fraud Crisis and Jeonse Lease Contracts
Korea Institute of Finance Presents 'Macroeconomic Risks and Policy Tasks of the Jeonse System'
Jeonse Has Benefits but Side Effects of 'Incomplete Private Contracts' Are Much Greater

[Image source=Yonhap News]

In the midst of a nationwide surge in jeonse fraud cases, there are calls to reduce the guarantee ratio of the jeonse system to prevent its side effects. Lowering the guarantee ratio is likely to lead to a shift toward 'guaranteed monthly rent contracts,' where part of the jeonse deposit is replaced with monthly rent. However, it is argued that this would incur less social cost than continuing with unstable private contracts.

On the 21st, a report titled "Macroeconomic Risks and Policy Tasks of the Jeonse System" released by the Korea Institute of Finance pointed out that the jeonse system poses risk factors both to contracting parties and from a macroeconomic perspective.

No penalty for landlords or compensation for tenants even if contract is breached at maturity

[Image source=Yonhap News]

The first problem identified is the lack of safeguards against counterparty risk. Recent jeonse fraud incidents stemmed from this issue. Jeonse contracts do not define penalties for breach of contract at the maturity of the transaction. For example, if the landlord fails to return the jeonse deposit after the two-year contract ends, this constitutes default, but the jeonse contract does not clearly specify what disadvantages the landlord faces or how the tenant is compensated in such cases.

Moreover, tenants find it difficult to thoroughly check the credit status of landlords who are effectively borrowing funds. Tenants make efforts to confirm collateral settings on the property, the priority of claims, and establish a fixed date registration. However, there are limits to knowing factors that affect the return of the jeonse deposit, such as the landlord’s credit status or delinquency history.

Researcher Park Chunsung, who authored the report, explained, "Banks evaluate repayment ability through income, credit scores, and past delinquency history when lending to individuals, and if delinquency occurs, assets and income can be seized. However, jeonse contracts are 'private transactions between individuals' mediated by housing with insufficient safeguards to secure repayment."

Landlords are effectively borrowing from banks but avoid credit evaluation and are outside LTV and DSR regulations

[Image source=Yonhap News]

When buying a house, borrowers are subject to soundness regulations such as Loan-to-Value (LTV) and Debt Service Ratio (DSR), but jeonse contracts are private monetary transactions between individuals and thus not subject to financial regulations, which is problematic. Park pointed out, "For example, if a landlord has a mortgage loan with an LTV of 40% on the house and enters into a jeonse contract for 40% of the house price, the landlord is effectively borrowing 80% of the house value. Since the landlord’s total debt level or income is not considered in jeonse transactions, DSR, i.e., the risk of jeonse deposit return, cannot be assessed, making it risky."

The risk of jeonse deposit repayment becomes very high when jeonse prices do not fall sharply in a short period and landlords cannot easily find new tenants at the end of the jeonse contract. This is why issues like reverse jeonse and "empty jeonse" arose during the Asian financial crisis, the global financial crisis, the savings bank crisis, and recent interest rate hikes. While transparent operation of jeonse contracts is a solution, jeonse is a 'legal private transaction,' limiting government intervention.

Reduce jeonse loan guarantees to raise awareness of jeonse deposit risks

Minister of Land, Infrastructure and Transport Won Hee-ryong is speaking at the ruling party-government council meeting on the eradication of jeonse fraud and victim support held at the National Assembly on the 20th. Photo by Kim Hyun-min kimhyun81@

What is the solution? Park said, "Adjusting guarantees for jeonse loans is feasible because public institutions can directly control the pace and scale," adding, "The guarantee ratio should be lowered to inform the market that jeonse deposits can be an economic risk factor."

Due to the guarantee system, financial institutions’ credit screening has not functioned properly, and tenants have been able to easily obtain loans. This also explains the paradoxical phenomenon of a significant increase in jeonse loans during housing price rises even as deposits increased.

Although the guarantee system was designed to help tenants prepare jeonse funds, it also serves as a guarantee for the risks related to landlords’ loan situations, which is problematic. When landlords take out loans, the funds are paid to landlords through jeonse contracts. This means guarantees are provided for loans to landlords who have never undergone financial institution verification and are in the blind spots of LTV and DSR regulations.

Park warned, "Currently, jeonse loans are known to be almost 100% guaranteed through guarantee companies (Housing and Urban Guarantee Corporation, Korea Housing Finance Corporation, SGI Seoul Guarantee). If this ratio decreases, the scale of deposits financed by loans will shrink, and there is a high possibility of conversion to monthly rent contracts. Tenants benefit by living in jeonse at a lower cost than monthly rent during low-interest periods, and landlords benefit by raising lump sums through jeonse, but maintaining these incomplete private contracts causes much greater social costs."

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