Lifting of Debt-to-Income Rule: A Poisoned Apple?

With the government temporarily lifting the debt-to-income rule around the capital except in the three richest Seoul districts, banks are working on formulating new lending standards.

The debt-to-income rule prohibits a borrower from spending more than 50-60 percent of his or her annual household income to pay the principal and interest on a housing loan. With the temporary lifting of the restriction, however, banks can decide their lending ceilings for themselves according to a borrower’s income.

Banks have welcomed the relaxation of rules on home equity lending, which is their main source of income. Many say, however, that the deregulation is a poisoned apple and that more home equity lending will lead to a higher delinquency ratio.

○ Trying to find solutions

Banks plan on coming up with new lending standards next month and start marketing home equity loan products. They will revise internal rules on debt-to-income ceilings and set up a computation system that prevents them from making loans when the amount surpasses the ceiling.

Banks can start mortgage lending based on the new rules from mid-September.

The difficulty, however, is setting the debt-to-income ceiling in the course of screening applicants for home equity loans. The government has allowed banks to set the ratio on their own according to the debt-servicing ability of borrowers.

Banks, however, say a sharp easing of the ratio will lead to a higher delinquency ratio of home equity loans, eventually leading to bank defaults.

The biggest problem lies with the government’s intent to benefit low-income people through the new rule. The ceiling on the debt-to-income ratio was lifted but the loan-to-value ratio, which restricts lending according to the price of a housing unit, remained the same, making it easier for low-income households to borrow more to buy more expensive houses.

With many low-income households having borrowed a considerable amount, excessive lending marketing by banks could lead to more household loans going bad.

A banking source said, “It is difficult to interpret the government’s intent in letting financial institutions decide debt-to-income ratios on their own. While the ratio should be drastically lowered to boost real estate transactions, the financial soundness of banks should also be considered.”

○ Competition for home equity lending to intensify

Banks say time is needed for home equity lending to increase since housing transactions need to recover for demand for home equity loan to rise.

They still expect, however, that home equity loans will increase sooner or later since deposits are increasing after the rise in the benchmark interest rate and the need to utilize this money because of rising defaults in real estate project financing.

In the first half of the year, when the real estate market was at its worst, banks continued to increase the volume of home equity loans since their interest rates were lower than those offered to companies. In June, home equity loans took up a record-high 65.2 percent of all household loans.

One fear is that the competition in home equity loans will intensify among banks based on how much they ease their respective debt-to-income ratios.

A banking source said, “To start, banks will likely raise their debt-to-income ratio just 10-20 percent for fear of a rise in their delinquency ratios. After one or two banks lift their ceilings completely, competition will intensify.”

yunjung@donga.com weappon@donga.com