Rate cut deepens household debt woes

By Yoon Ja-young

The Bank of Korea’s latest rate cut to a record low 1.5 percent is adding to concerns over household debt.

With the United States expected to start raising its key rate in September, experts say that the government should prepare measures to handle the snowballing debt.

They say the amount is too high compared to repayment capability amid stalled income growth, and risks of defaults will increase if interest rates start to move up.

The country’s balance of household debt has been surging over the past few months, standing at 1.0993 quadrillion won at the end of the first quarter.

Economists agree that the key rate cut will accelerate household debt.

“Everybody is aware that the interest rate is low. Those who need money will of course get a loan,” said Kim Young-do, a research fellow at the Korea Institute of Finance. “Household debt related with real estate has been especially increasing, and will continue to grow for some time.”

He said household debt is a worrisome issue, with the market expecting the United States to start raising its key rate in September amid the economic recovery there. If that happens, Korea should follow, lest it see an exodus of global funds.

“Of course, the U.S. rate hike doesn’t mean an immediate explosion. As each borrower is in a different condition and has differing capability to pay back, not all borrowers will go insolvent.”

He said it is thus crucial for lenders to consider each customer’s ability to pay back, especially in the case of an interest rate hike.

Park Deok-bae, a research fellow at the Hyundai Research Institute, said the key rate cut is like a double-edged sword for household debt.

“More people will be getting loans, which is bad, but those who already have loans will see less of an interest burden,” he said.

Park agrees that the balance of the household debt is huge.

“The focus should be on whether it is controlled properly. The government should prepare measures for each scenario, such as the U.S. key rate hike or people having to pay back not only interest but also the principal on their mortgages. The household debt should be controlled from a micro perspective,” he said.

Huh Won-jea, a research fellow at Korea Economic Research Institute, said the previous rate hikes by the United States shows that once it starts raising rates, it will raise them a number of times, continuously.

Between 2004 and 2006, for instance, the federal open market committee raised key rates by 0.25 percentage points each time. As a consequence, the U.S. key rate rose to 5.25 percent in June 2006, starting from 1.25 percent on June 2004.

If the United States does that again, “Korea would have to raise the rates on concerns over a capital exodus. But as the balance of the mortgages is bigger than ever, there will be dismal consequences if the prices of mortgaged houses fall,” he said.

On top of preparing for the rate hike to minimize the negative effects, he said increasing disposable income would be a fundamental solution.