Overleveraged borrowers on edge of bankruptcy

Rising rates, sluggish markets combine to become deadly cocktail

By Cho Jin-seo

Staff reporter

Everyone knew that the banks' record-low interest rate wouldn't last for ever. But not everyone realized that the normalization of the rate could become deadly, when it is combined with a slumping housing market.

Lenders are following the Bank of Korea to increase their loan interest rates, after the central bank increased its base rate by 0.25 percentage points for the first time in 17 months earlier this month. The change is believed to cause some 7 trillion won ($5.83 billion) of additional interest payments for corporate and households in debt. But the actual financial burden might be much larger than that.

The most severely hit are the people who made late bets in houses, when the industry is now showing clear signs of a bear market.

“This loan is becoming a real headache for me,” said Yoon, a 34-year-old father of a newly born baby, who bought a two-bedroom apartment in Seoul's Gaepo area two years ago.

Nothing looked bad in 2007 when Yoon bought this tiny 35-square meter house at 700 million won ($580,000), with a 200 million won mortgage. Property prices in this southern Seoul area were soaring month by month on anticipation of redevelopment. Newspapers were touting that investment in apartments was an “invincible” strategy. Many took a heavy mortgage like Yoon as it was regarded as the only plausible option for salaried workers to have a house in Seoul.

This year, however, things began to look different. As the housing market began to slump, the same apartment with Yoon's is now on sale at a 10-percent discounted price. But the real problem is no one is willing to buy _ a critical issue for those who bought properties as a short-term investment. Furthermore, the interest rate increase is making his financial pain more acute.

“You can write that I was screaming in agony,” Yoon said. “Actually, the interest on my mortgage is very low now, and an increase of 0.25 or even 0.5 points itself won't hurt me badly. But the problem is that no one wants to buy the house now, and an increasing interest rate will make people even less inclined to take a mortgage to buy a house.”

Debt trap

Such is the trap of the housing debt that the government is worrying about. Most economists believe that the current base rate of 2.25 percent is too low, and the central bank should raise it to around 3 percent within this year. But policymakers are afraid that doing so will aggravate the malicious circle of high interest rates and falling property prices, and push the overleveraged borrowers into bankruptcy.

A further increase in the interest rate will cost the “house poor” population — homeowners who struggle to pay off their mortgage dearly. As of the end of May, corporate and households loans at commercial and savings banks were standing at 1,400 trillion won ($1.17 trillion), according to data compiled by the Bank of Korea. Because of the record-low interest rate that had lasted until this month, there was some 40 trillion won of net lending between January and May this year.

A rate hike of a half percentage point means that borrowers in total need to make additional interest payments of 7 trillion won ($5.9 billion) every year. The amount does not include low-credit loans made by small private lenders, where the interest burden is already painfully high.

The prospect of a higher interest rate is also absorbing liquidity in the market. According to the central bank, some 9 trillion won of net deposits were made at commercial banks over the 10 days since the announcement of a rate rise on July 9.

The construction industry, as well as the conservative newspapers like Chosun who rely heavily on advertisement revenue made from builders, is worried that a further interest rate might lead to a sudden burst in the property market bubble. It will also punish speculative investors, which are in fact half of the house owners in Seoul — only 55.1 percent of homes are inhabited by their owners.

Nonetheless, the government and the central bank are expected to push for further increases of the base rate. Most economists also agree that housing debt is only one aspect of the economy, and the government should not sacrifice its monetary policy for the sake of speculative property investors.

“(The central bank) needs to show policy direction to the market,” said Hyun Oh-seok, the chief of Korea Development Institute, in an interview with Yonhap on Sunday. “The interest rate is currently at a very low level. It should be raised, so that the central bank can restore some room to maneuver.”

For mortgage takers, the economic crisis has just begun.