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Mortgages in a nutshell

Author: Sagi Moldovan, Mortgage Consultant, Dolev Mortgage and Finance

In this article I will summarize the world of mortgages and present its main points in order to better understand its foundations and laws, so that we will know how to use this instrument to our advantage.

What is a mortgage?

A mortgage is a loan for all intents and purposes, from a bank or an external entity, in a lien on property against the loan, as collateral for the repayment of the debt. Unlike a commercial loan (a regular loan from a bank) in which the bank lends money for a trip abroad, a family event, closing an overdraft at the bank, starting a business, etc.

In these cases, the risk on the part of the bank is high, it has no real guarantee of receiving the money back, and therefore these loans are priced by the bank at high interest rates, in order to compensate it for the risk it takes.

On the other hand, in housing loans, the bank mortgages the property in its favor, so that even if the borrower does not meet the mortgage payment, the bank will take the property and repay the balance of the debt.

As a result of this security of the Bank and restrictions imposed by the Bank of Israel, the interest rates on mortgage loans are significantly lower than on commercial loans.

This is the main advantage of a mortgage over a commercial loan. There is an intermediate situation called “mortgage for any purpose” which means taking a loan from the bank in the lien of the property, but not for housing purposes but for any other purpose, such as closing an overdraft, buying a car, a family event. A loan to buy property B is also defined as an all-purpose loan. These loans are priced at 1%-2% more than a regular mortgage, but they are significantly cheaper than a regular commercial loan.

The structure of a mortgage loan consists of many variables (some of which we will expand on later), such as a settlement schedule, various tracks, interest rates, indexation or foreign currency, spread over short or long term repayments. This complexity is confusing and difficult to understand. Let’s try to put things in some order.

What does the bank check before issuing a mortgage?

In light of the above, it is important to understand that a bank will approve receipt of a mortgage only after examining two issues: (a) the quality of the customer, in order to ensure, to the extent that it can be assessed, that the customer will comply with the payment arrangement to be determined; (b) The nature of the collateral (the asset), in order to ensure, to the extent possible, that if and when the customer stops paying, the bank will be able to repay his debt from the property.

When examining the customer, the bank will find out details about the customer’s place of work, seniority at work, the amount of his net salary, his financial conduct as reflected in current account statements, and more. Another inquiry conducted from another direction is the state of the client’s health, which will be approved by the insurance company that will make life insurance for him.

In order to assess the quality of the collateral, the bank will examine the mortgaged property. The examination will include registration of rights in the Land Registry or the Israel Land Authority, or with the mortgage company, the existence of additional liens, the valuation of the property by an appraiser, and more.

It is important to note that the existence of only one problem in one of the tests I detailed above may lead to the bank’s refusal to grant a mortgage.

Mortgage price

A bank loan means renting money, and as with any product rental, as long as we hold the product and enjoy it we pay for it, the same applies to the money received from a mortgage loan. As long as we keep and enjoy the bank’s money, we pay for it. The bank collects its salary through two channels: interest and indexation.

The various mortgage tracks differ from each other in the way these payments are collected by the bank. A mortgage loan, whether taken entirely in one track or divided into several tracks, includes four fixed components: the loan amount, the track, the number of years until the mortgage is fully repaid, and the interest rate. The first three components are our “product”, while the last component is the “payment” that is required to be paid.

The common expression “mortgage market” indicates a situation in which there is competition between banks for customers. But make no mistake, the manner of bargaining over the interest rate at the bank is different from bargaining in a regular market. It is conducted according to a number of rules: (a) the quality of the customer. A “rich” customer will receive cheaper interest on his loans than a “poor” customer; (b) Price comparison. It is almost impossible to get a significant discount if the bank knows that you trust only it, that is, you will not go get an offer from another bank. The more offers a customer comes to the bank with from competing banks, the greater the chances that he will receive better offers and the broader the base for meaningful bargaining. When comparing the prices offered to us by the bank, it is important to compare prices for the same product on the same tracks.

Types of routes

We will briefly touch on the advantages and disadvantages of the five main routes. The tracks differ from each other in stability and instability of the interest rate, and in indexation and non-linkage to the index or to foreign currency.

Track

Advantages

Disadvantages

CPI-indexed fixed interest rate
In this track, the interest rate is set at the time of taking out the mortgage and does not change at all until the end of the loan period. In this track, the loan fund and interest rate are linked to the consumer price index.
  • The interest rate on this loan is fixed and does not change.
  • For long periods there is a steady increase in the monthly repayment.

 

  • The initial interest rate is relatively low. This means a low initial return.
  • In long-term deployment, the loan principal in the first years of the loan does not decrease.

 

  • At partial or full repayment in the middle of the period, there may be payment of interest capitalization differences, known to the people as an “early repayment penalty”.
Forex-linked variable interest rate
In this track, the interest rate is set as the average interest rate of banks in London.The interest rate changes every three or six months, and the loan principal is linked to a predetermined foreign currency.
  • The initial interest rate on this loan, as of today, is very low.
  • In this track, the fund is linked to foreign currency: dollars, euros, etc. Forex volatility will directly affect the balance of the loan principal, for better or for worse.
  • This means initial return tracked interest rate volatility There is no capitalization difference fee.
  • Interest rates fluctuate and can go up or down every three or six months.
  • The loan principal is always going down.
Unindexed fixed interest rate
The interest rate does not change at all and there is no indexation.
  • The safest route. In this track, there are no changes from the beginning of the loan to the end.
  • High starting interest which means a high initial monthly return.

 

  • The loan principal is always going down.
  • There may be an interest differential fee when partially or fully repaid.
Unindexed interest rate, changes every 1/3/5 years
In this track, the interest rate may change at the “station” that was set, in accordance with the change in the base interest rate, but here the fund is not indexed.
  • The loan principal is always going down.∙ The “stations” allow partial or full repayment without the capitalization difference fee.
  • High starting interest which means a high monthly return.

 

  • There may be a change in the interest rate at the “station”.
Prime Interest
The interest rate may change every month, depending on changes in the Bank of Israel’s interest rate.
  • The loan principal is always going down.∙ You can always repay without the capitalization difference fee.
  • In this track, the frequency of interest rate changes is the highest. It may change every month in accordance with the Bank of Israel’s interest rate decision. As a result, the monthly repayment can change for the better or for the worse.

 

Mortgage Refinancing

Refinancing a mortgage means taking out a new mortgage loan instead of the old one. The purpose of refinancing is usually to shorten the mortgage payment period or save on the general expenditure on mortgage payments. Another goal is to extend the mortgage payment period.

The possibility of recycling is due to three reasons:

  1. from the ability to partially repay the mortgage as a result of a sum of money received by the borrower as a gift, inheritance, savings plan or study fund opened, etc.;
  2. from an increase in the borrower’s income or from a decrease in his expenses, which allows him to increase the amount of the monthly repayment;
  3. The decline in the interest rate in the economy that enables obtaining a mortgage at a lower interest rate.

These changes will allow the period to be shortened or the monthly repayment reduced. What all these examples have in common is that refinancing the mortgage on them will save tens of thousands of shekels and sometimes even hundreds of thousands of shekels. Another option of refinancing is necessary when the borrower finds himself in financial difficulties and finds it difficult to meet the established payment arrangement. In such a situation, the borrower will be forced to refinance the mortgage in order to spread out the balance of the principal for a longer number of years in order to reduce the amount of the monthly repayment. As a result of the turnover, the borrower will lose money, but at least he will remain in his property.

Tips and myth-busting

Expensive and cheap, cheap and expensive: A completely real act in a man who went into his bank branch to take out a mortgage of NIS 1 million and told the teller that I could not return more than NIS 4,000 a month. The clerk checked and told him, since you are a long-time customer of ours, we will only allow you to return NIS 4,000 a month. His friend followed him into the bank to take out a million-shekel mortgage. The clerk told him that his refund would be NIS 5,500 a month. The two met and argued over which mortgage was better. What do you think?

Well, the correct answer is that the other friend’s mortgage is better. Over the years, a person who pays “only” NIS 4,000 per month will pay about NIS 350,000 more than his friend.

A basic rule in mortgages states that the cheapest at the beginning is expensive at the end and what is expensive at the beginning is cheap at the end. The higher the amount I initially pay, the cheaper my mortgage will be, and vice versa.

My Bank: Most people naturally turn to take out a mortgage at the bank where their bank account is managed. They feel safer there. That’s fine, but it’s important to understand that the bank is working to increase its profits and not to increase the profits of its customers. A customer who goes only to his bank is likely to have higher interest rates and less favorable terms than he could have received if he had contacted other banks and negotiated the interest rate and terms of the mortgage.

Interest rate: The same two friends from the previous story went these days to get a mortgage. One received an interest rate of 2.4 percent for 30 years on the CPI-indexed track and the other received an interest rate of 5.5 percent for 30 years on the unindexed fixed interest track. Again the friends discussed among themselves whose mortgage was better. What do you think?

In this case, too, the other friend whose mortgage interest rate was more than double that of his friend probably got a better mortgage. In the end, he will pay about NIS 250,000 less than his friend (based on the assumption that the indices will rise compared to today and will average 3% a year). The interest rate is a significant factor in weighing mortgage tracks, but certainly not the main one. The type of route and the layout of the years are much more significant.

Mortgage Advisor

The main role of the mortgage adviser is to “tailor” the right suit for the client. As you understood, it is not the loan amount that determines the amount of the monthly repayment, but the client’s capabilities. On the same loan amount can be built dozens of combinations of tracks. The mortgage adviser is required to clarify the following main questions: What is the client’s maximum payment ability? (That is, how much that customer can pay and still live comfortably and not sparingly.) Is there an expectation in the future of an increase or, God forbid, a decline in revenues? Will the customer have in the near term a sum of money that can be earmarked for repayment of part of the mortgage? In refinancing a mortgage, the consultant must examine the terms of the existing mortgage and compare them to the existing conditions in the economy today. Only on the basis of such clarification can the optimal mortgage mix be assembled for the customer.

Note: The positions and recommendations in the article reflect the personal and professional opinion of the writer, with the intention of adapting them in most cases. However, it is possible that in some cases not all recommendations will be appropriate . Therefore, it is worthwhile to examine each case individually and, if necessary, consult before implementing this or that recommendation.

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