Consumers seeking home equity loans are facing complex calculations due to rising interest rates. Typically, fixed-rate loans are preferred when rates increase, but the current situation is different. Variable rates are more than 0.5 percentage points lower than fixed rates, making them more attractive in terms of immediate interest burden. However, choosing a variable rate is not straightforward, as further increases in the benchmark rate could lead to higher future interest payments. This raises the question of which option is more favorable during a period of rising rates.
Currently, variable rates appear more advantageous. As of September 7, the fixed-rate home equity loans from the five major banks (KB Kookmin, Shinhan, Hana, Woori, and NH Nonghyup) range from 4.80% to 7.24%, while variable rates range from 4.28% to 6.65%. The lower end of variable rates is 0.52 percentage points lower than fixed rates, and the upper end is 0.59 percentage points lower. Given that the Bank of Korea typically adjusts the benchmark rate by 0.25 percentage points at a time, this difference is significant.
The lower variable rates are due to the differing speeds at which these products reflect market interest rate changes. The benchmark for fixed-rate loans, the five-year bank bond rate, quickly incorporates future benchmark rate expectations. In contrast, the variable rate benchmark, the Cost of Funds Index (COFIX), is based on the actual costs incurred by banks in raising funds through deposits and bonds, resulting in a slower response to market rate changes.
If reducing immediate interest payments is a priority, considering a variable rate may be worthwhile. This is also true for borrowers planning to sell their homes or repay their loans early within a few years. Conversely, if the prospect of increased principal and interest payments due to rising rates is concerning, a fixed-rate loan may be the safer choice. Variable rates are typically adjusted every six months or annually, meaning that if the benchmark rate continues to rise, monthly payments could increase. This is particularly relevant for borrowers with large loan amounts or high debt-to-income ratios, who may find it beneficial to lock in a fixed rate for a certain period, even if it is slightly higher.
For borrowers needing to maximize their loan limits, fixed rates are also advantageous. The Debt Service Ratio (DSR) stress test considers potential future rate increases by adding a certain percentage to the actual loan interest rate when determining limits. Products with frequently changing rates face greater burdens. For instance, when the stress rate for home equity loans in regulated areas is set at 3.0%, it is fully applied to variable rates, while only 1.2 percentage points (40%) is applied to a 30-year fixed-rate loan with a five-year adjustment period.
Ultimately, the decision should be based more on individual repayment capacity and the required loan amount than on interest rate forecasts. If reducing interest payments is crucial and there is capacity to handle future rate increases, a variable rate may be suitable. However, if the prospect of increased monthly payments due to rising rates is daunting or if maximizing loan limits is essential, a fixed rate should be prioritized.
* This article has been translated by AI.
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