Korea to introduce stress DSR system in February 2024

[Chung Chan-dong’s illust.]

The South Korean government will gradually introduce a system to regulate stress debt service ratio (DSR) for household loans starting from February 2024, a move aimed at strengthening household debt management. The system, once implemented, is expected to reduce individual loan limits by up to 16 percent compared to the current levels.

The Financial Services Commission (FSC) on Wednesday announced plans to implement the stress DSR system at banks and other financial institutions for variable-rate, mixed-rate, and periodic loans next year.

Stress DSR is a system that imposes a certain level of additional interest (stress interest) when calculating DSR, considering the possibility of increased repayment burden due to future interest rate hikes when the borrower executes the loan.

The stress interest rate is determined based on the difference between the highest household loan rate in the recent 5 years and the current benchmark rate (as of May and November each year), with a lower limit of 1.5 percent and an upper limit of 3 percent.

For variable-rate loans, the stress rate, which is the highest interest rate in the past 5 years minus the current rate, will remain unchanged. Mixed-rate and periodic loans will have a more relaxed stress rate than variable-rate loans because they have a partially fixed rate and therefore a lower risk of interest rate fluctuations.

In mixed-rate loans, the proportion of fixed interest rate during the entire loan term affects the level of stress interest rate. For a 30-year maturity loan with a fixed period of 5-9 years, 60 percent of the stress rate will apply to the variable rate, 40 percent for 9-15 years, and 20 percent for 15-21 years.

Periodic loans will have a more relaxed level of stress rate than mixed-rate loans. For a 30-year maturity loan, the stress rate applied to the variable rate is 30 percent for a rate change period of 5-9 years, 20 percent for 9-15 years, and 10 percent for 15-21 years.

Credit loans are subject to stress interest when the total balance exceeds 100 million won ($77,254), and the scope will be expanded later.

To alleviate concerns about a reduction of perceived loan limits for borrowers, the FSC plans to apply only 25 percent of stress interest in the first half of 2024 and 50 percent in the second half. From 2025 onwards, stress interest will be fully applied, resulting in a potential reduction of loan limits by a maximum of 9 percent in 2024 and 16 percent by 2025, depending on the type of loan.

According to simulations carried out by financial authorities, the stress rate is 0.6 percent, calculated as the difference between the highest interest rate in the past 5 years (5.64 percent in December 2022) and the latest rate (5.04 percent in October 2023), with a lower limit of 1.5 percent set by the authorities, resulting in a final markup of 1.5 percent.

In the first half of 2024, the rate is 0.375 percent as only 25 percent is applied, and in the second half, the rate is 0.75 percent as 50 percent is reflected.

The FSC expects to see a growing preference for mixed-rate and periodic loans or purely fixed-rate loans, which have a relatively low risk of interest rate fluctuations.