25.03.2010
 
The following is an excerpt from the Bank of Israel Report which will be published in April:
The Mortgage Market in Israel
 
  In the last two years there was an increase of 56 percent in the extent of new mortgages taken, and house prices increased by more than 30 percent.
  The low rate of interest at the beginning of 2009 and the expectation that it would continue to decline diverted mortgagors towards unindexed floating-interest mortgages; these mortgages reached a peak of 77 percent of new mortgages taken in February 2009, declining gradually during the year to reach 51 percent in December.
  Households' debt burden relative to disposable income remained at about 60 percent in Israel, lower than in countries such as the US, the UK, and eurozone countries.
  It is considered that the increase in the burden of mortgage interest payments following expected increases in the interest rate in 2010 will not have a serious impact on private consumption or on the stability of the banks.
  Banks in Israel, when considering granting a mortgage, examine the customer's repayment ability also at higher rates of interest, because in Israel there is hardly any market for mortgage securitization, and the bank bears the mortgage risk throughout the duration of the debt.
In the last two years there has been a 56 percent increase, gross, in the extent of new mortgages taken, and these reached NIS 65 billion, compared with NIS 41 billion in 2006–07. This rapid increase occurred concurrently with an increase of more than 30 percent in house prices since 2008, following several years when they hardly changed (Figure 1).
 
 
The increase in the extent of new mortgages is the result of the drop in interest rates, which was reflected in the mortgage market too, leading to an increase in demand for houses, also as investment assets. This was part of the trend evident in 2009 of investors searching for a better return in light of the low rates of interest obtainable from other investment channels, such as bank deposits and government bonds.
Mortgages are a major component of households' debt burden in Israel, and at the end of 2009 they constituted about 50 percent of households' total outstanding debt. Despite the rapid growth in new mortgages in the last two years, households' debt burden did not change to any significant degree; this can be seen from the ratio of their debt to GDP, or the ratio of their debt to disposable income, which is markedly lower in Israel than in the US, the UK, and countries in the eurozone. Thus, the debt/disposable income ratio in Israel was below 60 percent at the end of 2008, compared with 110 percent in the US and the UK (Figure 2). In addition, house prices increased in Israel since the beginning of the decade more slowly than they did in those economies.
The mortgage market in Israel underwent many changes in the last few years as a result of the decline in inflation rates and the structural reforms implemented. The share of CPI-indexed mortgages in total new mortgages fell steadily, and reached as low as 35 percent, compared with 61 percent in 2003. The share of CPI-indexed mortgages in total outstanding mortgages remains high––66 percent in September 2009.
 
 
The low level of interest and the expectation at the beginning of 2009 that it would be reduced even further in the near future diverted those taking new mortgages to unindexed floating-interest mortgages, the interest on which is the most affected by changes in the Bank of Israel interest rate. The share of these mortgages in total new mortgages increased steadily from the middle of 2008, and peaked in February 2009 at 77 percent, but it declined thereafter to reach 51 percent in December, as no further cuts in the interest rate were expected.
 
 
Outstanding unindexed floating-interest mortgages totaled NIS 43 billion in September 2009, and borrowers have benefited from relatively low repayments during the last two years, due to the low interest rate. Thus, average annual interest on new unindexed floating-interest mortgages taken in 2009 was 1.7 percent, compared with 5.5 percent on unindexed fixed-interest loans and 3.1 percent on the indexed fixed-interest loans.
The current Bank of Israel interest rate, however, does not represent a long-term equilibrium level: the interest rate is expected to increase gradually with the economy recovery from the worldwide crisis, and as it does, so will the repayment burden on those with mortgages. The question is whether that increased repayment burden resulting from the expected rise in interest rates will affect private consumption or the banks' stability. As those expected to be most affected are borrowers with unindexed floating-interest mortgages, we examined how much interest payments will increase for borrowers with these mortgages, based on various assumptions regarding the path of the interest rate. The results obtained suggest that interest repayments in 2010 are expected be about NIS 1 billion higher than their level in 2009, and the ratio of repayments to disposable income is expected to increase by 0.2 percent, a change not expected to have any significant effect on private consumption.
With regard to the risk to the banking system in Israel, the rates of financing in the mortgage market are far lower in Israel than the norm in other countries, which reduces the risk to a bank should a customer become insolvent. Furthermore, in Israel there is hardly any market for mortgage securitization, and the bank bears the mortgage risk throughout the duration of the debt. For that reason, banks in Israel, when considering granting a mortgage, examine the customer's repayment ability also at higher interest rates. Thus, a rise in interest in the mortgage market is not expected to affect banks' stability, although it is certainly expected to increase arrears in the mortgage market, which at the end of 2009 stood at 1.08 percent of outstanding housing credit.