Getting Started
Making the dream of home ownership a reality requires proper planning and an understanding of your financing options. For most people, home ownership is within reach. For many, home ownership is more affordable than renting.
Know Your Finances
The best way to prepare for buying a home is to understand your current financial situation and expectations for the future. Know how much money you are saving – and how much you are spending. Planning your finances is the first step to getting a mortgage.
Research Your Options
There are numerous loan products available in Israel and it is essential to identify the most appropriate product for each individual scenario. Make sure you understand how all of the mortgage products work. Pinpointing the correct mortgage, or mix of mortgages, can save you tens or even hundreds of thousands of shekels over the life of the loan.
A few things to keep in mind when researching your mortgage options:
- No single bank in Israel has every mortgage product
- Some banks have hidden costs in the “fine print”
- “Fixed rate” does not necessarily mean that the mortgage has fixed payments throughout the life of the loan
Knowing what products are available at which rates and the nuances of each product is essential when applying for a mortgage.
Which Mortgage is Right for You?
There are many factors you should consider when choosing a mortgage. As you learn about the different products that are available, keep the following information in mind:
- Your current financial situation and resources
- How you expect your finances to change in the future
- How long you plan on owning the property
- How the loan can be structured to minimize currency risk
- Your susceptibility to “payment shock”
- How comfortable you might be with the idea of your balance and/or mortgage payment fluctuating over time
- How rapidly you want to build equity
Know the Big Picture
The total cost of purchasing a property includes more than just the monthly principal and interest payments. There are also origination fees, appraisal costs, real estate taxes and other fees such as the lawyer, realtor and structural engineer which can add a significant expense to your home purchase. When planning your home purchase, be sure that you take into account all of the factors that will affect your final costs.
Common Mortgage Choices
Fixed vs. adjustable rate loans
There are many ways to structure a mortgage in Israel and it is crucial to pinpoint the variables that determine the most appropriate loan in each situation. Finding the right loan will save significant money over the life of the mortgage while minimizing the borrower’s risk.
Amongst the various mortgage products available, all of them can be broken down into two basic types of loans:
- Fixed rate mortgages
- Adjustable rate mortgages – ARMs
Furthermore, both of these mortgage types may be “linked” or “unlinked” to the Consumer Price Index (madad), also known as the “cost of living” index. When a loan is linked, the principal balance of the loan adjusts in tandem with madad.
Mortgages based on an adjustable rate – ARMs – typically enable the borrower to make lower initial payments, but may entail higher payments in the future if interest rates rise.
Mortgages with fixed interest rates are more predictable and less risky, but are available at a premium, as fixed rates are generally much higher when compared to rates on ARMs. Additionally, some fixed rate loans may incur pre-payment penalties when refinancing or paying off the loan.
A Note on Other Mortgage Options
Lenders have developed what can be termed “hybrid” mortgages to assist people in reaching their goal of home ownership. These loans can include combinations of fixed and adjustable rate mortgages. It is crucial to investigate all options to determine the best mix of loans for you.
More on Madad
Madad is calculated by Israel’s Central Bureau of Statistics and measures the average change over time in the prices paid by consumers for a “market basket” of goods and services. Linking a loan to madad causes the principal balance to adjust over time. For example, if the price of the market basket increases by 3%, the balance owed on a linked loan will also increase by 3%. However, if madad decreases, the balance will not necessarily decrease as it can never fall below a base index.
Fixed Rate Mortgages
With a fixed rate mortgage, interest rates are fixed throughout the life of the loan and monthly payments remain unchanged. As borrowers take on no risk for this type of loan, the banks charge a premium of between 2-4% more than on adjustable rate mortgages. These types of loans may incur pre-payment penalties.
Fixed rate mortgages work well for those who cannot afford to take any risk on their loan and need to protect themselves against increasing interest rates.
- Key Advantage: Predictability. The principal and interest payments do not change, allowing for better budgeting and financial planning.
- Key Disadvantage: The principal and interest payments are usually higher than those of adjustable rate mortgages. If rates decrease, fixed rate mortgages do not take advantage of the lower rates and pre-payment penalties may prevent refinancing the loan to lower rates.
Mortgages Linked to Madad
Both fixed and adjustable rate loans may be linked to madad. Linking a loan to madad results in the principal balance adjusting over time. For example: ₪100,000 is borrowed at 4% interest, fixed for 30 years. Assuming that madad increased 0.3% that month, the principal balance increases to ₪100,300 prior to the first payment. After the first payment, the principal balance decreases to ₪100,155. The interest rate of 4% will then be levied upon the new balance of ₪100,155 instead of the original balance of ₪100,000. When linked to madad, monthly mortgage payments vary throughout the life of the loan.
- Key Advantage: Low and fairly consistent monthly payments. This type of financing works well for people on a tight budget.
- Key Disadvantage: Inefficient means of paying down the principal balance of the loan as it grows in tandem with madad. May incur pre-payment penalties.
Adjustable Rate Mortgages
Adjustable rate mortgage (ARM) payments are generally lower in the beginning of the loan term when compared to fixed rate loans. However, the rate is “adjustable,” meaning it can adjust up or down according to changes in the index to which it is tied. This can result in significant monthly payment increases.
ARMs are a good solution for those looking to accumulate equity in their homes and do not expect to be in their home for a long time. However, because the interest rate can increase, you must have the resources to endure possible increases in your mortgage payment.
- Key Advantage: ARMs have lower initial monthly payments compared to fixed rate mortgages. Also, because rates are lower, a larger portion of your monthly payment goes toward principal. If rates drop, the loan adjusts and payments will be lower without needing to refinance.
- Key Disadvantage: If interest rates increase, monthly payments can increase significantly.
A Little More about ARMs
There are four basic components in all ARMs, and different mortgages combine them in different ways. While your broker can explain more about the ARMs available to you, here are some helpful definitions:
- Initial interest rate: The rate of interest you will pay until the first adjustment period. It will typically be 2-4% lower than a similar fixed rate mortgage.
- Index: This is the reference rate used to determine changes to your ARM’s interest rate. Your loan is tied to this index and as the index increases and decreases, the interest rate adjusts accordingly. Some examples of indicies commonly used for ARMs are the BOI Prime Rate, LIBOR, Makam and Ogen. Ask your broker for more detailed information.
- Margin: This refers to percentage points the lender adds or subtracts to the index to establish the actual interest rate you pay on your ARM. The margin stays unchanged throughout the entire life of the loan.
- Adjustment interval: This is the time between changes in your ARM’s interest rate.
Typical ARM adjustment periods may vary from monthly to every ten years.
With so many mortgage options to decide between, it is highly advisable to seek guidance from a qualified mortgage consultant. You can schedule a consultation, free of charge, with a First Israel Mortgage consultant or call +972-2-567-1349.
