An economic slowdown in Israel combined with a steadily appreciating Shekel have prompted the Bank of Israel to lower interest rates four times in the last twelve months in an attempt to stimulate the economy and weaken the Shekel. However, the Bank of Israel has clearly stated that the moves are not intended to boost the housing market. The Bank of Israel cited the slowing economy and specifically, the appreciating shekel as one of the determining factors in its most recent decision to lower rates.
One of the most critical monetary policy tools in the U.S. over the last 10 years has been the artificially low interest rates engineered by the Federal Reserve. This has enabled borrowers to refinance their loans and increase their spending on goods and services thereby adding a much-needed boost to the economy. So the question begs, if interest rates in Israel have been going down, why hasn’t Israel’s economy benefited from a wave of refinancing as is the case in the U.S.? The very short answer: onerous pre-payment penalties.
Mortgage refinancing helps stimulate the economy by increasing the consumer’s disposable income, perceived wealth, and confidence. Most economies are driven by consumer spending-and a wave of refinancing can spark a sustained surge in consumer spending as borrowers’ monthly expenditures are reduced. The cash that borrowers save can be used to buy much needed goods and services that they may not otherwise have been willing to spend on.
Pre-payment penalties are commitments by a borrower to make the interest and principal payments on their mortgage agreement for the entire loan term or face a penalty. Under no circumstances may the loan be paid off without the penalty being levied on the borrower. This includes refinancing, selling the home, or paying the loan off using savings or earnings. Today in Israel, there are very few options for long term fixed interest rates without the possibility of a pre-payment penalty. If a borrower wants to have the comfort of a fixed interest rate, the bank will demand in return the comfort of knowing that the borrower will pay the loan for the said 20 or 30 years. The banks do allow a payoff without penalty in one scenario: if interest rates have risen from the time the borrower took the loan (a scenario in which few borrowers would want to pay off the existing loan at a more attractive rate). The penalties, which are intended to protect the bank, can easily reach 10%-20% of the loan amount with no maximum limit.
The total of outstanding medium and long-term fixed rate mortgages in Israel is roughly 1 trillion shekels. Assuming that these borrowers were able to save 2% on average by refinancing- this would save households over 20 billion shekels per year putting thousands of shekels per year back into many families’ pockets. In the interest of stimulating domestic consumer spending the Israeli public would be well served if mortgage prepayment penalties were abolished. With the social protests still in Israel’s mind, perhaps now is a prudent time to examine if it is socially just to allow banks to take advantage of falling interest rates by allowing them to borrow money more cheaply, while disallowing the homeowner to do the same.