“Mr. Fischer: Let the people refinance”
An economic slowdown in Israel has prompted the Bank of Israel to lower interest rates three times in the last 6 months in an attempt to stimulate the flagging economy. 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, weaker domestic demand as one of the determining factors in its most recent decision to lower rates.
In the United States, the arguments are growing louder for a sweeping bailout of underwater homeowners. With mortgage rates in the US the lowest they have ever been in history, the proposed plan will allow more homeowners a chance to refinance at today’s rock bottom interest rates regardless of how much they owe on their home. With the new plan, any borrower who is current on their last six monthly payments can refinance to lower rates even if they already owe more than their home is worth. Leaving politics aside, economists expect it to help 3.5 million homeowners and give a much-needed boost to the U.S. 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 20,30, or even 40 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 100 billion shekels. Assuming that these borrowers were able to save 2% on average by refinancing- this would save households over 2 billion shekels per year putting thousands of shekels per year back into many families’ pockets. In the interest of stimulating domestic consumer spending the Bank of Israel would be well served by abolishing mortgage prepayment penalties entirely. With the social protests fresh in Israel’s mind, 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.
