Interest Rate Cuts 'Stuck' on the Way, Failing to Fully Reach Mortgage Borrowers

While the Bank of Israel interest rate is falling, mortgages are not adjusting accordingly. In recent months, there has been an increase in the interest margins charged by banks, which offsets a significant part of the interest rate reductions in the economy — this emerges both from conversations with sources in the mortgage market and from Bank of Israel data. For variable-rate mortgages, offers were received with a margin of 1%–1.3% above the base rate (derived from the relevant government bond yield). This is while in the past, margins had already reached about 0.7%.

From conversations held by Globes with sources in the industry, it appears that, paradoxically, for those who estimate that the Bank of Israel interest rate will continue to fall, a "window of opportunity" of a few weeks has been created, during which it will be possible to take out mortgages at a better interest rate, even in a scenario of another one or two reductions in the Bank of Israel interest rate.

The Bank of Israel interest rate currently stands at 3.5%, and therefore the prime rate (given to the bank's best customers) stands at 5%. From this, mortgages on their various tracks are derived. Until a year ago, the interest rate in the economy stood at 4.5%, and since then Governor Amir Yaron has carried out several reductions. In July, as in the previous decision, he reduced it by 0.25%.

Banks are currently enjoying record demand for mortgages, which totaled over 11 billion shekels last June. Despite the weakness in the residential real estate market, many Israelis are only now required to take out mortgages on deals signed two or three years ago, as part of various financing campaigns that delayed the mortgage taking date until the apartments were delivered. The high demand and low flexibility of those buyers transfer the power into the hands of the banks and allow them to increase the margins.

The banks' efforts not to reduce the interest rate to the same extent that the Bank of Israel is lowering it can certainly be seen from the official bank data. If in July of last year the average shekel interest rate on mortgages stood at 5.11%, then in the past July it stood at 4.74%. Although this is a decrease of 0.37%, as mentioned, the Bank of Israel interest rate decreased during that period by 1%.

"The Bank of Israel interest rate is only the starting point"

Especially notable is the conduct since last April. If in April the average interest rate on mortgages fell to 4.73%, then in the two months that followed it climbed to almost 4.9%, and in the past July it fell again to 4.74%, after two interest rate reductions (0.5% in total). Also here, the interest rate fell by less than 0.2% within two months, less than half of its reduction rate in the economy.

Tomer Varon, the financial advisor of RiseUp and host of the podcast 'The Money of Life Itself', has recently published data from mortgage offers that his clients received in non-indexed variable interest tracks. On a mortgage of a little less than 300 thousand shekels for a non-indexed variable interest, which is updated every two years according to government bonds, an interest rate of 4.64% was offered, a margin of 1.33% above the relevant bond yield (3.3%). In another track, for a mortgage of 400 thousand shekels, an interest rate of 4.46% was offered at a margin of +1%. Although these are only initial offers, and it is possible and desirable to hold negotiations to reduce the margins and the interest rate, this is an indication of the margin increase that the banks are trying to achieve.

When taking out a mortgage, Varon explains, "we tend to look at the Bank of Israel interest rate, but this is only the starting point. Ultimately, what determines how much we will pay for the mortgage is the long-term interest rate from the bond market, and on top of that the margin that the bank adds above the cost of raising the money. When this margin increases, customers benefit less from the decrease in the interest rate in the economy."

Varon notes that "in recent months, it is possible to see that in some tracks the decrease in the interest rate in the economy is not fully translated into a decrease in mortgage interest rates. That is, the cost of money for the banks has decreased, but the interest rate offered to customers has decreased at a slower pace. The banks are trying to open the margins after they were eroded during the high interest rate period, and in practice, part of the decrease simply remains with the banks."

He emphasizes that "for the public, the meaning is clear: do not assume that an interest rate cut will automatically guarantee a cheaper mortgage. Precisely in such a period, it is important to examine the offers in depth, compare between banks, and conduct more stubborn negotiations."

A financial source operating in the mortgage world says that "it was very difficult for the banks precisely when the interest rate rose in the past. They went then and reduced the margins, also because of the competition in mortgages, but also because it was difficult for the public to take them. The result was a decrease in apartment purchases. So now, when the interest rate is falling, they are trying to return and raise the margins, and open them back up (make the mortgage more expensive against the interest rate decrease in the economy)."

When the interest rates rose, the banks reduced the margins dramatically, even to a loss, in order to keep the oxygen in the market, and absorbed the interest rate increase. Now when the interest rate is falling, they are returning them a little.

Window of opportunity for taking out mortgages

Due to the race to raise margins by the banks, and also due to the way the various mortgage tracks are composed, a kind of window of opportunity for taking out a new mortgage has paradoxically been created in these weeks. So that whoever thinks today that the governor will reduce the interest rate in the coming half-year one or two more times, precisely in these weeks an opportunity has been created for him for a cheaper interest rate on the mortgage than in the future.

As Yonatan Berliner, owner of a software company in the field of mortgage consulting, explains, "whoever expects a continued decrease in interest rates, it is worth it for him to take the first mortgage release now and not wait. And if someone can pay the first payment on the mortgage to the contractor now, and he is considering whether to wait for example half a year in anticipation that the interest rates will continue to fall, then it is better for him to take it today. The reason is that together with the decrease in interest rates in the market, the margins are expected to climb, and even if the interest rate in the economy continues to fall, the banks will offset part of the decrease by raising the margins." Berliner adds that in the mortgage tracks with variable interest rates, "the margin (the addition) is much more important than the interest rate in the first period."

Berliner emphasizes, however, that "of course, whoever thinks that the interest rate will rise, or even remain unchanged - it is better for him to wait." Still, he adds a small caveat, in the context of index-linked mortgage tracks. "Regarding index-linked tracks, since the interest rate expectation there is different, and the two upcoming indices are expected to be very high, it is worth in any case to postpone their execution by a month and a half (until after the middle of next September)."

Despite the banks' struggle to raise margins, the Mortgage Consultants Association asks to reassure the public. They say that despite the recent data, at a historical level the margins today remain low. "Despite the slight increase in margins recently, the banks' interest margins are still significantly lower than they were in the zero interest period," they say in the association. "In our assessment, the banks understand well that the Bank of Israel interest rate will not return to these zero levels, and therefore the margins will also not return to the high levels that were then."

"The margins are starting to undergo readjustments"

In recent years, they add and emphasize, the margins narrowed to very low levels when the interest rate was at its peak. "The excess capital in the banking system alongside the reduction in market volumes led to the banks absorbing a significant part of the interest rate increase and lowering margins," they say in the association. "In the variable tracks, where it is easy to see the margin above the base rate, we moved from an average margin of about 2%+ in the past to an unprecedented low of 0.2%–0.4%. Today, with the change in market conditions and the beginning of interest rate cuts, the margins are starting to undergo readjustments to a level of about 0.8%–1% — still less than half of what they were accustomed to charging in the past.

"Mortgage consultants were and remain the main drivers of competition in the market, and together with the Bank of Israel's reforms, we have a decisive part in curbing price increases. Our role is not to intervene in pricing, but to open barriers and create strong competition in any market condition — on price, products, and transaction adaptation, to ensure fair conditions for borrowers."