Micha Selya is a former Lehman Brothers and Bank HaPoalim mortgage analyst. He is currently an analyst with AIG providing quantitative analysis for the European Union, Middle East and Africa regions.
Taking out a mortgage in Israel can be a daunting prospect. Not only do you have to contend with the challenge of communicating in a foreign language, but you are also encountering for the first time a financing system that is most likely very different to what you are used to. This short write-up presents a concise overview of the different types of mortgages offered by Israeli mortgage banks, as well as providing homebuyers with useful information that will facilitate and simplify the process.
In the US and in the UK, when you need home financing you can easily arrange a mortgage loan for 30 years at a fixed or floating rate. Of course, things could never be that simple in Israel. Few borrowers take a single mortgage loan for one term and at one rate. Rather, the banks encourage borrowers to break up their mortgage (we'll explain how later) into any number of smaller loans - each with its own specific characteristics and loan repayment schedules. Sounds confusing? Let's go through each type of loan.
Fixed rate, Shekel-denominated, CPI-linked
- This is a NIS-denominated loan that can be taken for 5-30 years. Typically, the interest rate the bank will offer will increase along with the loan term. While the interest rate remains fixed for the full term of the loan, the bank adjusts the remaining outstanding amount you owe based on the official levels of inflation reported by the Bank of Israel.
I know, you're already lost... Ok, here's an example: Let's say you take a NIS 100,000 loan for a period of 20 years at a fixed rate of 5%. Your fixed monthly payment of principal and interest will be NIS 659.96â€¦as long as inflation is 0%. After the first year, you would have paid back almost NIS 3,000. Now, if inflation was 5% during that first year, your remaining balance would be readjusted to NIS 101,863 and your monthly payment would be readjusted to be NIS 692.95. Heavy prepayment penalties exist for early repayment or refinancing of this loan. However, these prepayment penalties only apply if the market interest rates at the time of early repayment or refinancing are higher than the interest rate on your mortgage. In Hebrew, this loan type is referred to as Tzamud L'madad, reebit kavua
Floating rate, Shekel-denominated, Dollar or Sterling-linked
- This is another NIS-denominated loan that can also be taken for 5-30 years. The interest rate is based on the LIBOR index and the addition of some fixed margin. The outstanding principal balance of the loan is regularly adjusted as the NIS/$ (or NIS/Sterling) exchange rate fluctuates. No prepayment penalties exist on this loan. In Hebrew, this loan type is referred to as Tzamud L'dollar (Sterling), reebit mishtana
Floating rate, Shekel-denominated, non-linked
- This loan is NIS-denominated and can also be taken for 5-30 years. The interest rate is determined by taking the Bank of Israel Prime Rate and subtracting some fixed margin. The principal balance of this loan is never adjusted according to inflation or some foreign exchange rate. No prepayment penalties exist on this loan. In Hebrew, this loan type is referred to as Lo Tzamud, reebit mishtana
The "hybrid" loan
- Each mortgage bank in Israel has its own version of this loan. Typically, it is NIS-denominated, linked to the CPI and has a fixed rate for a specified number of years. Depending on the set conditions of the loan, the interest rate adjusts every 1, 3, 5 or 10 years. At these reset dates, the borrower is given the option of prepaying or refinancing the remaining balance of the loan at no penalty.
- New immigrants, young couples buying a home for the first time, as well as those buying a house in a development area, are often offered a government loan. These loans are NIS-denominated, linked to the CPI and have a fixed rate of 4% for a period of 25 years. You can find an online calculator at the Ministry of Housing website, www.moch.gov.il/moch/DBapplicationsDotNet/MOCH_Mahshevon.aspx
, which will calculate how much of a government loan you are eligible to receive, based on certain criteria and information that you will have to provide (unfortunately, this feature is only available in Hebrew). No prepayment penalties exist on this loan. Although the Israeli government is actually providing the loan to the borrower, the loan is initially processed and serviced on a monthly basis by the mortgage bank - just like any other mortgage loan.
Mixing and matching
When fixed interest rates are low, borrowers want to take a fixed rate loan. Of course, the bank would rather not give the borrower a low fixed rate for 30 years because they are not earning as much money over the long term. Therefore, banks typically will offer to slightly drop the fixed rate if you agree to take a chunk of your mortgage at a floating rate. In a low fixed rate environment it is advisable to take 70-80% of your mortgage at a fixed rate and the remaining 20-30% at either a hybrid or floating rate.
When floating rates are low, the bank may be fine with the borrower taking 100% of the mortgage at a dollar-linked and floating rate. That may not be such a bad idea since the borrower always has the right to refinance the loan at a fixed rate in the event that the shekel devalues against the dollar or floating rate interest rates begin to rise. Of course, the refinancing options could be limited in the future, leaving you with either a high floating rate or the option to refinance at a very high fixed rate.
All in all, mixing and matching may reassure you that you have hedged your risk so that you are not totally exposed to inflation, currency or interest rate risk. Of course, don't forget that all these economic factors are linked and ultimately there is no perfect hedging solution.
The table below summarizes the pros and cons of each mortgage type:
|Fixed rate, Shekel-denominated, CPI-linked|
- When interest rates are low, a low rate can be locked in for the long term.
- The outstanding balance of the loan is adjusted by the inflation rate.
- Even if salary increase is above the inflation rate in the long term, in the short term, salaries may lag behind the inflation rate.
- Prepayment penalties.
|Floating rate, Shekel-denominated, $ or £ linked|
- Good for those whose salaries are $ or £ linked or denominated.
- Loan can always be refinanced if NIS/$ rate deteriorates or if floating interest rates rise.
- No prepayment penalties.
- Interest rate shocks.
- NIS/$ typically adjusts when inflation is rising and fixed rates are going up leaving limited refinancing options.
|Floating rate, Shekel-denominated, non-linked|
- Even in hyper-inflationary environments, the balance is not adjusted.
- No prepayment penalties.
- Interest rate shocks.
- When inflation is high, the Israeli Prime Rate typically rises as well.
- A very low fixed rate can be locked in for the period before the reset date.
- No prepayment penalties at the reset date.
- Excellent for those borrowers who can time a reset date to coincide with an expected salary bonus/maturing of keren hishtalmut.
- Interest rate shocks if no good refinancing option is available.
For those who are building a home in Israel while paying a mortgage elsewhere, or alternatively while paying rent, most mortgage banks offer graces on the loans. Two types of graces exist in Israel - partial and full. Under the terms of a partial grace, only interest must be repaid during the grace period. Under the terms of a full grace, no payment is made during the grace period and any interest that should have been paid is added to the loan balance and is paid back as part of the loan once the grace period ends. Graces are not offered on the zakaut loans and some banks do limit graces to certain loan types.
How much do you need to put down?
In the good old days in Israel, banks would rarely provide a loan for more than 50-60% of the value of the home. Typically, borrowers would need to bring along loan guarantors that the bank could sue in the event of non-payment. Nowadays, it's a totally different story. Banks are willing to lend up to 95% of the value of the property while using a mortgage insurance product offered by AIG's Israeli subsidiary, EMI. More information on EMI's product can be found on their webpage: www.emiltd.com
Visit Israelhomeowner.com to view its full selection of articles.
Disclaimer: This article does not constitute legal or professional advice but rather a discussion of general issues. Readers are advised to receive professional advice before making any decisions or entering into transactions.