Mortgage Prime Rate – The New Bank of Israel Policy
The Bank of Israel issued an announcement in which it allows the prime interest rate on the mortgage to be raised. How can this decision affect us?
First, what is Prime Interest Rate?
The Bank of Israel is the Bank of the Banks. It lends money to commercial banks, and they in turn lend the money to us customers. The daily interest rate that the Bank of Israel lends to commercial banks is called the Bank of Israel interest rate and today is the lowest interest rate that has been on the market in recent decades – 0.1%.
In order for banks to lend money to their customers, they must demand a margin so that they can earn more than what they pay to the Bank of Israel and also cover their operation costs. The margin agreed today in the market is 1.5%.
The Prime interest rate is the Bank of Israel interest rate + the margin. At the time of writing these lines the prime interest rate is 1.5 + 0.1 = 1.6%
Mortgages in Israel are usually provided in a number of ways.
You can take a part of the mortgage at a fixed interest rate, which is a fixed number throughout the life of the loan. For example an interest rate of 4%. At a fixed interest rate, the risk is usually very low, because if the interest rate of the Bank of Israel rises, then the interest rate on the mortgage does not change. Even if inflation rises this interest rate does not change.
Part of the mortgage loan can also be taken with a percentage that can grow according to the consumer price index. For example 3% + the change in consumer price index. In this route, if inflation rises, then interest payments will also rise. The bank offer this arrangement to cover itself from inflation risks.
The next arrangement is to set and interest plus the prime interest rate. For example Prime + 1%. This means that if the prime is 1.6 today then the interest rate on this track is 1 + 1.6 = 2.6 percent. Prime interest rates have been very low in recent years but if economic conditions change it can also rise. A change in the prime interest rate can greatly increase the monthly payments, so this route carries a risk if an interest rate increase is indeed expected.
In the past, because the rise in the prime interest rate could have dramatically affected the volume of the monthly payment, the Bank of Israel has limited the mortgage tracks so that there will be no more than a third of the loan linked to the prime interest rate. Now, probably due to expectations of low interest rates, the Bank of Israel has decided to allow an increase in the weight of the loan route at prime interest rates.
It is very important to consult experts in the field to understand whether we should change our mortgage composition these days. Simulations must be made on various assumptions of what will happen to interest rates in the future to understand how the decision will affect our monthly payments. Those with longer loans are more susceptible to the risk of an increase in the prime interest rate that may affect our monthly payments.
What is the mortgage price? We know that there is a percentage interest rate that will affect how much we will pay for our mortgage loan. But what exactly is this price and what affects its magnitude? What affects our mortgage price?
This price is determined both by the Interest rate and by loan’s duration.
I recommend asking the bank for the total amount we will have to repay of principal and interest as of today over the loan period. If the bank offers us several different options for the composition of the loan, then the amount of interest and principal that will accrue over the course of a lifetime will allow us to compare the options.
If you speak Hebrew, I invite you to watch a video I made about what is important to know when taking out a loan!
Dr. Yael Hadas, PhD in Political Economics and Government, Harvard University, Head of the Economics Program at the International School at IDC Herzliya, and General Manager of Schocken Publishing.
* This should not be seen as a recommendation to take out a mortgage. Consult with mortgage experts to get a recommendation that is right for you personally.