'Switching to fixed rate costs 200,000 won more a month' — why borrowers still choose variable despite rate hike

A borrower surnamed Lee took out a 600 million won ($403,000) variable-rate mortgage two years ago to buy an apartment in Gangbuk-gu, Seoul. When the Bank of Korea recently raised its benchmark interest rate, his anxiety grew. He is currently paying an annual rate of around 4.2 percent, but with further hikes on the table, he is weighing whether to switch to a fixed-rate loan. Fixed rates are running about 1 percentage point higher, which would add a significant amount to his monthly principal-and-interest payments.

A borrower surnamed Kim faces a similar dilemma. He must settle the balance on an apartment with an assessed value below 600 million won by the end of this month, and is torn between a six-month variable rate in the low-4-percent range and a five-year fixed rate in the high-4-percent range. Additional BOK rate hikes raise the prospect of a rising variable rate, but the nearly 1-percentage-point gap between the two options is hard to ignore — and choosing the variable rate could also reduce his borrowing limit under the tightened stress debt service ratio rules.

The Bank of Korea's first benchmark rate increase in three and a half years has deepened the strategic dilemma for mortgage borrowers. Fixed-rate home loans are conventionally seen as the safer bet in a rising-rate environment, but with fixed rates now running up to nearly 1 percentage point above variable rates, the choice is far from straightforward.

Variable-rate loans offer lower rates for now, but borrowers face a tighter borrowing ceiling under the strengthened stress DSR regulation. Experts say the first step in any loan strategy is to decide clearly whether the priority is the loan limit or the interest rate.

The fixed-rate mortgage range at the five major banks — KB, Shinhan, Hana, Woori and NH — stood at 4.77 to 7.49 percent annually as of Thursday, while the variable rate (six-month new COFIX) ranged from 4.13 to 6.58 percent, according to financial industry data. The upper end of the fixed-rate range was 0.91 percentage points higher.

The gap between fixed and variable rates has been widening steadily of late. At the end of last year, the upper end of the fixed rate exceeded the variable rate by 0.36 percentage points. By March 3 that gap had grown to 0.59 percentage points, and on Wednesday it reached 1.04 percentage points.

The divergence reflects the different benchmark rates underlying each product. Fixed-rate loans are tied to the five-year bank bond yield, which moves directly with the government bond market. As inflation concerns mounted in the first half of this year amid tensions in the Middle East, market rates rose, pushing the five-year bank bond yield from 3.499 percent at the end of last year to 4.428 percent as of Thursday — a gain of roughly 0.9 percentage points.

Variable-rate loans, by contrast, are benchmarked to the new COFIX, which reflects banks' funding costs. COFIX is a lagging indicator, and banks have had little incentive to aggressively raise deposit rates given overall household lending volume controls, so it has risen more slowly.

In a rising-rate environment, locking in a fixed rate for the long term is generally the recommended way to limit interest costs. Financial regulators have encouraged fixed-rate borrowing as a risk-management measure, and banks have waived prepayment penalties for borrowers switching from variable to fixed rates as part of that effort.

Yet with fixed rates holding well above variable rates, borrowers are not taking the bait. Variable-rate borrowers accounted for 58.4 percent of new mortgage lending in May, the highest share since June 2021, when the figure was 60.5 percent, according to the Bank of Korea. "If the fixed rate were just a little lower, I would have switched without hesitation," Lee said. "The difference in monthly interest alone runs to tens of thousands of won, so it's a real dilemma."

Using the upper-end rates as of Thursday, a 300 million won loan (30-year term, equal principal-and-interest repayment) would carry a monthly payment of 2.09 million won at the fixed rate of 7.49 percent annually. The same loan at the variable rate of 6.58 percent would cost 1.91 million won a month — about 200,000 won less.

Banks expect the preference for variable rates to persist for now. "The rate gap is wide, and COFIX — the benchmark for variable loans — is rising more slowly than bank bonds, so the mood is to save on immediate interest costs where possible," a loan officer at a commercial bank said. "If the loan amount is not large, staying at the lower rate may well be the better option for the time being."

Variable rates are not always the better deal, however. For borrowers whose priority is the loan limit rather than the rate, a fixed-rate loan may be the smarter choice. Financial regulators apply a stricter stress DSR calculation to variable-rate loans, which can significantly reduce the maximum amount a borrower can take out.

Under the third phase of the stress DSR framework, a buffer of about 1.2 percentage points is added to the actual rate when calculating DSR for fixed-rate (periodic) loans, while about 3 percentage points is added for variable-rate loans. Borrowers whose DSR exceeds 40 percent are ineligible for bank loans.

In a simulation run at a commercial bank, a salaried worker earning 100 million won a year could borrow up to 516 million won on a fixed-rate mortgage at 5.5 percent annually (30-year term, equal principal-and-interest repayment). The same borrower taking a variable-rate mortgage at 4.5 percent annually could borrow only 476 million won — a reduction of about 40 million won.

Experts advise borrowers to decide upfront whether their priority is minimizing interest costs or maximizing the loan amount before settling on a strategy.

"Choosing a variable rate triggers the stress DSR, which can sharply reduce the borrowing limit," said Kim Eun-jin, head of Leo Loan Research Institute. "If the loan is short-term or the amount is small, variable is likely the better choice, but most borrowers with modest incomes who are preparing to buy a home are gravitating toward fixed rates."