By Moshe Wilshinsky
Ma Nishtanah HaMortgage HaZeh
Understanding Banks with open ARMs
In Israel they are called “Mishtanae” (pronounced Mish-Ta-Neh) and in the US they are called “ARMs” What really 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 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 that can happen, what it means to you.
For example if you take a loan from the bank based on three percent interest annually, ten years from now on that same loan, the bank may charge you ten percent annually. Again, this is one of many possibilities, but what is definite is you have no idea what it may cost in the future.
The good news is that adjustable does not mean that your Mortgage bank can suddenly decide on its own to triple your annual interest rate. The “Adjustable” aspects are dictated by only a couple of factors, through which you can have some sense of when and why the interest rate of an adjustable rate mortgage might change.
There are primarily two factors that are used to calculate the interest rate you pay with an adjustable interest rate mortgage. There is the Index (“Ogen” in Hebrew) and the Margin (“Hefresh” in Hebrew). Together the two are added together to determine the interest rate. What’s tricky, perhaps, is that there are different types of indexes, each of which behave differently and therefore will change based on different circumstances.
For example the Prime Interest Rate Index, which is determined by The Bank Of Israel and is up for review regularly, can theoretically be changed at any time. If The Bank Of Israel sees the need to increase or decrease the cost of borrowing they will push the rate up or down. Conversely The Bank Of Israel can leave the rate unchanged for long periods of time if they do not see justification for a change. The Prime Interest Rate Index is an example of an index set by the government. In contrast certain indexes, for example the London International Bank Offer Rate or LIBOR, are market driven and based on an international market of what interest rates are paid for on certain loans based on the currency and length of time the loan needs to be paid back. This is an example of a market driven index.
In order to understand the basics of why any particular Index would be increased or decreased in the future requires understanding a bit about them. So in the case of the Prime Interest Rate Index you are looking at changes in the Israeli economy, more importantly The Bank Of Israel‘s reaction to these changes, determining if your interest rate (and remember your monthly payment) might go up. In contrast with the LIBOR index you need to look at what is happening to economy of the country of the currency used e.g. the 3 and 6 month US$ LIBOR indexes are very common in Israel. In order to anticipate change you need to pay attention to developments in the US economy. The 3 and 6 month US$ LIBOR indexes are also examples where the maximum frequency of change is predetermined e.g. The 3 and 6 months respectively so if you have a 6 month US$ LIBOR index used in your loan the rate cannot change more frequently than once every 6 months. There are indexes that change as frequently as every month to as infrequently as every 5 or 10 years.
It is important to note that I have been illustrating how the interest rate changes, but even with a mortgage that uses a 10 Year LIBOR index where the interest rate will not change for 10 years, borrower’s cost in NIS can change monthly because of changes in the currency exchange rates. In the same respect, a loan in NIS that is fixed for 10 years but linked to Madad (Tzamud Madad), even though it may be considered by the bank and even The Bank Of Israel as a fixed rate loan, a borrower will see their monthly payment change as well as their principle change based on Inflation in Israel. Currency and indexing are two factors that affect the monthly payment even if the interest rate does not change.
So we have the Indexes used in Adjustable Rate Mortgages, the currency you are borrowing in, and if you are linked to Madad (Tzamud Madad) all affecting both the cost you are paying for the money you borrowed and how much money you need to pay monthly. Getting in to the details of various indexes and their behavior is beyond the scope of this article. The point I want bring to your attention is that as with any relationship, when someone offers you open Arms, make sure they are appropriate for you.
About the author
Moshe Wilshinsky is the CEO of Moville Mortgage & Finance Ltd. Contact information: Israel: Dial: 073-796-2226 and then press the special 711 Bizness Magazine extension. In the U.S., dial: 201-377-3418; in the U.K., dial 208-596-4501. Website is at: www.movillefinance.com