"As Household Debt Increases, High-Income Earners' Opportunities to Acquire Real Estate Grow"... Loans Widening Inequality

Korea Economic Research Institute on 'Household Debt and Income Inequality in Our Country'
Sacrificing Consumption Resources to Acquire Non-Financial Assets
Asset Price Decline May Undermine Financial and Economic Stability

A study in South Korea has found that the increase in household debt can act as a factor expanding income inequality. Since most domestic household debt is used for acquiring non-financial assets, this results in a decrease in income for low-income households while high-income households experience an increase.

According to the Bank of Korea on the 26th, Hwang Seol-woong, a senior researcher at the Bank of Korea Economic Research Institute, and Kim Su-hyun, a professor at Chonnam National University, among others, presented this analysis in their recently published report titled "Household Debt and Income Inequality in South Korea."

The study analyzed the patterns of household debt in South Korea using data from the Korean Labor Panel Survey between 2004 and 2021. It found that since 2018, a period of rising housing prices, most new debt was incurred for mortgage loans. The research team explained, "Since 2018, the number of new household debt cases for housing acquisition surged to around 1,700, compared to fluctuating around 1,000 cases before 2018," and added, "Even for rental deposits such as jeonse, the number of cases increased after 2018, unlike the previous period."

The number of new loans for housing acquisition increased more among higher-income households. The research team noted, "Considering that non-financial assets are generally acquired through secured loans and that the scale of assets held by low-income households is smaller compared to high-income households, it is even more difficult for low-income households to acquire housing without using leverage," and added, "Under the current macroprudential regulations, household debt relatively grants higher-income households more opportunities to leverage for housing acquisition."

Looking at the outstanding balance of household debt for housing acquisition, the amount per loan case increases proportionally with income. According to the report, this gap widens further when including rental deposits, especially for the highest income quintile, which increased more compared to other income groups when rental deposits were included. In contrast, the outstanding balance of debt for consumer goods remained minimal throughout the period, as loans for consumer goods are mainly based on the borrower's credit and consist of small loans compared to secured loans for asset acquisition.

Additionally, in South Korea, an increase in debt leads to a decrease in the proportion of consumption rather than securing funds for consumption. This is because the purpose of existing or new mortgage loans is primarily for acquiring non-financial assets. The research team explained, "The ratio of spending on luxury items such as dining out, private education, and vehicle maintenance, which are closer to luxury goods rather than necessities, decreases compared to food expenses. This indicates that despite an increase in market income, households do not have sufficient funds for consumption due to burdens such as principal and interest repayments." They analyzed that households may sacrifice current consumption to acquire non-financial assets to increase future and permanent income, which can lead to a reverse causal relationship where income inequality increases later.

According to the report, theoretically, household debt is used for 'consumption smoothing' by households facing temporary liquidity constraints, and as a result, it is known to increase overall economic utility.

However, the economic reality we face is different. The research team pointed out, "Household debt is actively used for acquiring non-financial assets regardless of consumption smoothing, showing a different pattern in terms of scale and persistence compared to theoretical household debt," and warned, "Households maintaining excessively high debt are vulnerable to various internal and external negative shocks such as asset price declines, income reductions, and liquidity contractions."

They continued, "Households carrying debt to the extent that they must reduce consumption may find it difficult to repay principal and interest due to external shocks like interest rate hikes, which can lead to defaults and pose risks to the soundness of financial institutions," and cautioned, "If asset price declines occur simultaneously, deleveraging pressure increases, leading to forced asset sales and further declines in asset prices, which can undermine financial and economic stability."

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