Hidden risks behind jeonse
Business Focus reporter Kim Da-ye shares personal experience with readers regarding whether jeonse deposit should be considered as household debt
This is the second of a series highlighting the economic aspects of various sectors such as baseball, ramyeon, erectile dysfunction drugs, gambling, crime, tobacco and alcohol to name just a few. — ED.
By Kim Da-ye
In January I decided to move out of a three-bedroom apartment in a building that was 31 years old and set to be demolished and rebuilt in a couple of years. When I made up my mind, little did I know that moving into a new home is easy but moving out is not.
The two-year contract ended the same month, but the landlady asked me to start house-hunting after she found a new tenant. She did not have enough cash to return my 120-million-won (about $106,000) deposit, so she would have to pay me back with the deposit from the future tenant.
Under Korea’s rental system, jeonse, the tenant pays a large amount of money at the beginning of a contract as a deposit, which the landlord must pay back when the contract ends. This is instead of paying monthly rent and the landlord invests the deposit to earn money equivalent to rent.
It took my former landlady nearly two months to find a new tenant. In the meantime, I had to forego several places I viewed and liked. The landlady wasn’t sorry for being unable to pay back her 120-million-won debt on time.
Deposit as debt
Deposit for jeonse is technically a debt landlords owe to their tenants although both parties tend to forget that with the former enjoying more bargaining power.
In the Bank of Korea’s statistics, deposit for jeonse is not included as part of the nation’s household debt because jeonse is a deal between individuals.
The amount of household debt announced every month only covers loans from financial institutions ranging from banks, mutual savings associations, insurance companies and credit card firms to even authorized moneylenders.
As of the first quarter ending in March, the amount stood at 911.4 trillion won, and the latest report by the Korea Chamber of Commerce and Industry said that the portion of the household debt against the gross domestic product (GDP) was 81 percent in 2010 _ higher than the OECD average of 73 percent.
As mounting household debt became Korea’s biggest economic weakness amid the ongoing global crisis and as the sluggish real estate market is at the center of the problem, it has become inevitable to ask if deposits for jeonse should be considered as part of the country’s household debt and if the debt problem is even more serious than we thought.
“In relation to ‘risks’ to the economy, the jeonse deposit should be included as part of household debt. During the financial crises in 1997 and 2008, we experienced the problem of landlords struggling to pay back jeonse deposits amid falling housing prices. The current total of household debt that only covers loans from financial institutions may be statistically correct but does not fully reflect reality,” said Song Tae-jung, the chief economist at Woori Financial Group.
A report issued by the Bank of Korea in April agreed with Song’s view. The report said that the actual size of household debt is likely to be larger than the official figure because jeonse deposits are effectively debts owed by landlords.
There are no official statistics for the amount of deposits that landlords owe to tenants. The only credible source would be Statistics Korea’s annual survey of 10,000 households, which showed that in 2011, each Korean household had an average of 18.8 million won in security deposit assets and 16 million won of the same type in debt.
As of November 2010, there were 17.574 million households, indicating that the amount landlords owed tenants in deposits amounted to over 280 trillion won.
Most experts say that the deposit is the landlord’s debt as well as the tenant’s asset, so they offset each other, registering no impact on the balance sheets of Korean households.
But what if landlords used up the cash and face problems in liquidating assets to pay back the deposits? That’s when the deposits turn into problematic debt.
One of the reasons why I decided to move out of the previous apartment was a decision by the landlady to raise the deposit by 20 million won, just five days before the contract expired. By law, I could have rejected the belated notice and stayed there under existing terms.
Her reason for raising the required sum was because she needed extra cash to support her daughter’s education abroad. As it took longer and longer to find a new tenant to live in a building that will soon be demolished, she even placed the property on sale. And in this sluggish real estate market, she couldn’t find anyone who would pay the price she wanted.
Luckily, she found a new tenant, and didn’t have to sell the property at an undesirable price. This isn’t the case for many other landlords.
In the past few years, housing prices remained stagnant or dropped but deposit amounts for jeonse went up sharply because of the low interest rate. The national average of jeonse deposits for apartments rose 7.7 percent in July from a year ago while that of prices to sell property climbed 3.3 percent, according to KB Kookmin Bank, the country’s leading lender.
It means that landlords are borrowing more and more from tenants while the prices of securities are falling. Now the jeonse market is completely on the landlords’ side, but when the tide turns, those who have taken large deposits may suffer more.
There are already signs that things are turning for tenants.
As the housing market obviously faces a downhill trend, experts are warning tenants to be careful about moving into houses that are already mortgaged.
If the house has already been mortgaged and landlords are forced to auction off their properties, the tenants will be compensated after the first creditor. That means the tenants can lose part or all of the deposit.
“Defaults on jeonse deposits won’t affect a country’s financial system because the money isn’t borrowed from financial institutions. But it will affect individuals and definitely their consumption,” said one economist who requested anonymity because of the sensitive nature of the topic.
What the economist didn’t say was that many tenants borrow jeonse deposits from banks and those loans can go sour if landlords cannot return deposits on time.
The government seems to be increasingly aware of the risks.
The state-run Korea Housing Finance Corporation (HF) introduced a measure last Tuesday to help tenants move out when their landlords do not return deposits.
A large portion of loans from banks for jeonse deposits are backed up by the state-run company. People who borrowed a jeonse deposit under the guarantee by the HF cannot not qualify for the guarantee again before they pay back the existing debt.
The new measure enables low-income tenants who struggle to get back their deposit from landlords to borrow additional money and move into a new home.
The risks to tenants stemming from the sluggish housing market, however, are still largely overlooked because of their status. Most of the media and government attention has been focused on homeowners who are expected to suffer from the burst of the housing bubble.
The research institute belonging to the KB Financial Group highlighted in a report in June the vulnerability of tenants as the loan-to-value (LTV) ratio, the portion of mortgage amount against value of the property, increases.
When a jeonse deposit is counted as part of the loan, there are some 341,000 households that live in the properties whose LTV ratio exceeds 70 percent, the institute said.
As of 2010, some 3.77 million households were renting houses under the jeonse system. The institute’s own survey also showed that some 966,000 households were renting mortgaged houses.
“For mortgaged houses, some tenants get discount on jeonse deposit. But due to the shortage of housing available for jeonse, the risks to tenants, aren’t considered,” the report said, urging that tenants should receive bargains on mortgaged properties.
End of jeonse?
In Korea, landlords have let properties under the jeonse system for several reasons.
It is common for homebuyers to let houses when they do not have enough money or are buying properties for investment purposes. The deposit for jeonse is an interest-free loan that usually comes in a huge sum.
Some people use the jeonse system when they have to move to a different neighborhood while others, mostly owners of multiple homes, intend to earn interest from the deposit.
While the idea of not paying monthly rent is considered attractive, the system that is unique to Korea is gradually losing its allure to landlords.
Amid low interest rates, landlords are either asking for more deposits for jeonse or turning to collecting monthly rent.
At the same time, as house prices fall, people no longer want to invest in properties and make less use of the jeonse system.
For this reporter, a tenant, the system unique to Korea was immensely useful. It helped me save more and enjoy better spending power with more disposable income.
When I had to move out, however, it made me rethink. One of the strangest parts is that the new tenant and I had to match our moving-in and moving-out dates to smoothen the transfer of the jeonse deposit. A string of households had to move on the same day for this purpose. And there is nothing new or odd about it, but it is a custom.
For the new home, I viewed nearly 10 places. Just before signing a contract, many landlords changed their minds to monthly rent from jeonse. Despite the odd experience, I searched only properties available on jeonse terms.
Would I prefer jeonse to monthly rent in the future? Most likely, yes. But I am not sure if the system will continue to exist.