INSIGHT

One Way to Achieve Responsible Mortgage Lending

Both the lender and the borrower bear the effects of housing price changes in shared responsibility mortgage. Photo credit: KIF
Both the lender and the borrower bear the effects of housing price changes in shared responsibility mortgage. Photo credit: KIF

The idea behind shared responsibility mortgage is to link the principal balance and interest payments to a house price index.

Introduction

There is a vicious cycle between excessive mortgage lending and asset price bubble in the Republic of Korea as Koreans continue to borrow money to buy homes despite soaring housing prices. In 2018, the mortgage loans in the Republic of Korea reached $26.6 billion due to a greater number of people moving into new homes. Unfortunately, borrowers are usually the ones that shoulder the loss while lenders are almost free from risks whenever housing price bubble bursts.  

To curb this cycle, it is critical to establish an arrangement that would make lending institutions more cautious about extending mortgage loans. One of the viable options is shared responsibility mortgage.

Analysis

Mortgage is a kind of loan in which a bank or lending institution buys the property or real estate for the borrower, who makes monthly payments with interest until the loan is paid in full.

In a typical mortgage loan, the borrower bears both the losses and profits from changes in the house market value while the lending institution is mostly unscathed. For example, even though housing prices fell by 10%, a person who purchased a home for 1 million Korean won with a 900,000 mortgage loan would still need to repay the lender the same amount.

Because they are not obliged to bear some of the losses when the housing bubble bursts, lenders continue to extend easy credit access to borrowers who are too optimistic about the housing market. This high demand from borrowers drives up housing prices.

Meanwhile, in a shared responsibility mortgage, both the lender and the borrower bear the profits or losses from changes in housing price. This mortgage is equity-like in nature and is based on an established housing price index. If home price falls, the principal repayment balance and interest on the outstanding loan amount will be adjusted proportionately.

Basic Concept of Shared Responsibility Mortgage

Potential benefits of shared responsibility mortgage include stricter and more responsible mortgage lending and greater stability for household net assets and the housing market.

The Republic of Korea’s 2013 Shared Mortgage and 2018 Profit Sharing Mortgage for the Newlyweds applied the concept of shared responsibility mortgage.

Implication

To broaden the consumer base for shared responsibility mortgage, it is important to establish a reasonable housing price index to be reflected in the repayment terms and develop related derivatives and insurance products to hedge lenders’ risks. Extensive promotion and marketing of its efficiency as an instrument, when both aspects of assets and liabilities are considered, is likewise necessary. Borrowers must be oriented not to consider shared responsibility mortgage as a liability.  

References

J. Lee. 2015. The Speed and Trajectory of Household Debt in South Korea. Federal Reserve Bank of San Francisco.

M. Song. 2019. Concept and Potential Benefits of Shared Responsibility Mortgage. Korea Institute of Finance.  

Yonhap. 2019. Korea’s Mortgage Loans Rise $ 26.6 billion on-year on 2018:Data. The Korea Times.

Ask the Experts

  • Min-Kyu Song
    Director of Capital Markets Division, Korea Institute of Finance (KIF)

    Min-Kyu Song served as Senior Advisor to the Chairman of Financial Services Commission in 2017 and 2018. Prior to joining KIF in 2010, he worked for Korea Development Institute, Korea Securities Research Institute, and the Bank of Korea. His areas of expertise include capital markets, international finance, payment system, and financial development. He earned his Ph.D. in Economics from the University of Texas at Austin in 2005.

  • Korea Institute of Finance (KIF)

    The Korea Institute of Finance provides expert analysis for the development of the Republic of Korea's financial sector and financial policy.

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   Last updated: October 2019



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