With the sign of recovery from the global financial crisis, Korean housing prices once again showed an upward trend in the beginning of 2009. One of the several factors behind this phenomenon in the real-estate market was an increase in the amount of mortgage loans from banks in the first half of the year. According to government’s statistics, this period saw a more than 3 trillion won increase in the amount of mortgage loans from banks every month. Consequently, outstanding mortgages from banking and non-banking sectors stood at 332.8 trillion won as of June, 2009. Too much liquidity poured into the real-estate market all at once, and this speculative tendency caused housing prices, especially in the metropolitan area, to go up significantly.
This is a similar picture that we saw in the United States a few years ago. Thanks to some banks and other financial institutions, many Americans in the past were able to get mortgage loans relatively easily when buying houses. Those banks allowed people to get mortgage loans amounting to 80 to 90 percent of their home prices with almost no strings attached. Even a 100 percent lending called “Subprime Mortgage” was also provided as one of the options for home buyers. When housing prices dropped considerably, their lives turned into a nightmare. A steep decline in housing prices brought about a sharp rise in mortgage delinquencies and foreclosures of homes across the country. It also caused some banks involved in the indiscriminate mortgage lending to go out of business as a result. This was a prelude to the global financial crisis.
Government tightens financial regulations
Although Koreans have yet to experience such a steep decline in housing prices, statistics above show us how risky this mortgage lending is here in Korea as well. That is why Korean government introduced a series of measures to put the brakes on the rising mortgage loans from banks and other financial institutions last year. The most well-known financial regulations for housing prices are Loan-to-Value ratio(LTV) and Debt-to-Income ratio(DTI). The government tightened DTI and LTV in a bid to reduce the amount of loans. So what are those two regulations all about? How are they being applied in Korea right now?
LTV stands for the loan amount expressed as a percentage of the market price of the property. If the LTV ratio is 50 percent, a borrower can’t receive loans exceeding 50 percent of the home price. In other words, when a borrower owns an apartment in southern Seoul valued at 900million won, his or her mortgage loan amount cannot exceed 450million won.
Whereas LTV only considers the value of the house, DTI puts an emphasis on the credibility of mortgage borrowers. Whether those who want mortgages have the capability to pay them back is an important factor in preventing mortgage delinquencies. For example, if somebody wants to get loans to buy an apartment in southern Seoul valued 900million won, the payment of the principal and interest for the loan each year should be less than 40 percent of his or her annual income. If the income is 60 million won a year, he or she can get mortgage loans to the extent where his or her annual payment for the principal and interest is less than 24 million won.
DTI and LTV were first put in place during the last administration in an effort to stabilize the skyrocketing housing prices in the speculative zones. Since the middle of last year, the government has gradually expanded the ranges of districts and financial institutions to which the regulations are applied and has also tightened them by adjusting the cap. Currently, three upscale districts in southern Seoul are subjected to 40 percent of the DTI cap, along with the rest of Seoul and other cities in the metropolitan area affected by a DTI rule of between 50 to 60 percent. LTV is now being applied in and around Seoul with a 40 to 50 percent ratio. In October last year, the government also added non-bank lenders such as insurance companies, mutual financing companies and savings banks to the kinds of financial institutions subjected to the DTI regulation on mortgages like bank lenders.
DTI and LTV as effective tools, not cure-all
Those two renowned regulations have been used and applied in Korea to reduce the amount of mortgages and stabilize housing prices. On the surface, according to government data showing the increase in the balance of banking sector mortgages, DTI and LTV have been proven as effective tools, at least in the financial circles.
From March to July 2009, banking sector mortgages jumped sharply with 3 to 4 trillion won increase each month. But after the government expanded LTV and DTI rules to more regions in July and in September respectively, the amount of mortgage increase compared to previous month was on a steady decrease as shown in the graphics above. In addition, stricter LTV and DTI regulations, which came into effect in October, also helped reduce the amount of mortgages not only from banks but from non-bank lenders afterwards. This downward trend in mortgage lending brought down housing prices in the metropolitan area a bit as well, but it stopped short of fully stabilizing the market.
This result suggests that the DTI and LTV regulations are effective to a certain degree but probably have limited impacts on the market in the long-term. Looking at the statistics, the decrease in the amount of mortgage lending is attributed to these two regulations at least. The fact that the government’s policies have been lowering the amount of mortgage loans, thereby preventing too much money from flowing into the real-estate market is significant.
These financial regulations can’t be a cure-all for all the problems in the real-estate market in Korea, and also can’t guarantee stable housing prices that last long. But what is important is that the regulations are expected to contribute to securing soundness of the credit system in the financial sector.
In the long run, in order to stabilize the housing prices, Korean government will also have to implement real-estate polices related to housing supplies and taxation, while maintaining and tightening the current financial regulations on mortgage loans in the coming months. These measures and close monitoring on real-estate prices will prevent a crisis such as credit crunch that we saw in the United States from happening here in Korea.
FIN POL 