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The maximum interest on mortgages extended by commercial banks has surpassed 10 percent. The fixed interest rate on mortgages, which was between 6.7 and 8 percent around this time last year, has jumped to between 8 to 10 percent, while variable interest rates, which were between 6.2 to 7 percent, have risen to between 6.7 and 8.4 percent. Overall, the interest burden has risen between 1.5 to 2 percentage points in the span of just a year. A person who took out a W100 million (US$1=W1,269) mortgage now has to pay between W130,000 to W180,000 more a month than at this time last year.
The reason is that the interest rate has risen on bonds that banks have issued using their own credit ratings as collateral. Following the U.S. financial crisis, Korean financial institutions have held on tightly to cash, either won or U.S. dollars, bracing themselves for worsening conditions. This has created a shortage of money in circulation, and short-term financing between financial institutions has stopped. Banks are competing to hike interest rates to raise money on their own through issuing bonds.
But bonds issued by banks are unpopular among investors. With few buyers, these bonds depreciate in value and their interest rates rise. Moreover, brokerages and even investment trusts are selling their bank bonds in a bid to secure cash in case they face a run on deposits, and this is leading to a further depreciation in the value of bank bonds and causing their interest obligations to rise. The interest rate on three-year bank bonds, which was in the 5 percent range in January this year, jumped to 8 percent by early October.
Financial institutions have extended more than W300 trillion in mortgage loans. And the earnings of households that have taken out loans using their homes as collateral have either decreased or have remained the same. If interest rates continue to rise, we will see more and more households unable to service their debts. The delinquency rate on mortgage payments was 0.38 percent in June but rose to 0.43 percent in July and to 0.51 percent in August. The delinquency rate at secondary financial institutions like mutual savings banks has already surpassed the danger zone, rising to between 2.45 to 6.31 percent. If home prices drop by a big margin in these circumstances, the entire financial industry will sink into insolvency.
The government says there is no problem since the delinquency rate is still low, while the average loan-to-house value (LTV) among financial institutions is still around 49 percent. But the U.S. government was saying the same thing until last fall before the subprime mortgage crisis ended up driving the global economy into crisis.
Harvard economist Martin Feldstein recently proposed that the U.S. government should shift 20 percent of mortgage loans into long-term, low-interest loans to resolve the financial crisis. He is saying it would be more effective to decrease the volume of mortgages and so lower the financial burden on households to stem the depreciation in housing prices, rather than pouring rescue money into Wall Street. Although the situation does not exactly match our condition, those words are worth noting.
The government should check its macroeconomic policies on insolvent mortgage loans and look closely into microeconomic measures such as shifting double-digit interest mortgage loans into long-term, low-interest loans for low-income families, newlyweds and senior citizens.
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