In Israel they are called Mishtaneh (pronounced Mish-Ta-Neh). In the US they are called ARMs. What is an Adjustable Rate Mortgage (ARM) actually?
Today, in Israel and around the world, mortgage interest rates are increasing. If you have a nominal fixed rate mortgage (i.e. not linked to the Madad), you have nothing to worry about—it will not affect you at all. However, if all or part of your mortgage is adjustable, rising interest rates mean you will have an increase in the amount you pay on a monthly basis.
So what is an adjustable rate mortgage? The name says it all. “Adjustable” means something may or will change. “Rate” is short for “interest rate,” which refers to what your bank charges you for a given period to use the money you borrowed from them. Putting “adjustable” and “rate” together means that the amount of money (the cost) you are paying for the money you have borrowed may or will change. It is important to understand what will change, when the change can happen, and what it will mean for you.
For example, you take an adjustable rate loan from the bank. While it may have been three percent interest annually when you originally got the money, in ten years the bank may charge you six percent annually, effectively doubling your monthly payment. No one knows what the future holds, but what is certain is that you have no idea what it may cost in the future.
It is not as scary as it sounds though; let’s first understand what can be adjustable in a mortgage. The “adjustable” aspects are dictated by a number of factors that can give you some sense of when and why the interest rate might change.
There are two primary factors used to calculate the interest rate paid with an adjustable interest rate mortgage. There is the Index (ogen in Hebrew) and the Margin (hefresh in Hebrew). When added together, they determine the interest rate. What’s tricky, perhaps, is that there are different types of indexes, each of which behaves differently and which change based on different circumstances.
The Prime Interest Rate Index, which is determined by the Bank of Israel, is up for review regularly and can theoretically be changed at any time. If the Bank of Israel sees the need to increase or decrease the cost of borrowing, they can do that at any time. If the Bank of Israel increases the Prime Interest Rate, it will increase the interest rate on mortgages based on the Prime Rate. The Prime Interest Rate Index is an example of an index set by the government. In contrast, there are certain indexes—for example, the London International Bank Offer Rate (LIBOR)—that are market driven and based on an international market of what interest rates are paid on certain loans based on the currency and length of time the loan needs to be paid back.
Why are indexes increased or decreased? In the case of the Prime Interest Rate Index, it is due to the Israeli economy—more importantly, the Bank of Israel’s perception of the state of the Israeli economy. In contrast, with the LIBOR index, you need to look at what is happening to the economy of the country of the currency used, e.g., the three-month US dollar LIBOR index, is very common in Israel. How the markets react to developments in the US economy will determine how the LIBOR interest rate changes. An adjustable rate mortgage with the three-month US dollar LIBOR as the index by definition will not have an interest rate adjustment more frequently than once every three months. In most cases these mortgages are made in NIS and a borrower’s monthly NIS payment can constantly change because of the changes in currency exchange rates.
A mortgage that is fixed for fifteen years but linked to the Madad (Tzamud Madad) and even though it may be considered by the bank and even the Bank of Israel as a fixed-rate loan, a borrower will see his monthly payment as well as his principle change based on inflation in Israel on a monthly basis. This means the “fixed” aspect is almost academic because the actual cost to the borrower can increase on a nominal basis—thus, the interest is not fixed.
With interest rates increasing it is important to assess how your mortgage is structured, how/when it will be affected by interest rate increases and if it is still appropriate for you.
From all of us in the Moville family to all the Bizness Magazine readers and your families, Chag Sameyach!
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