This paper
explores the contribution of various factors to determining mortgage interest
rates in Israel. We use a unique database combining loan-level data on mortgage
loans originated by the Israeli banking system during 2010–13 with proprietary
data on assets underlying mortgage origination as well as several additional
variables designed to capture risk associated with regional real estate markets
and the extent of competition prevailing in the banking system. We show that
significant differences exist in real mortgage interest rates among different
locations and neighborhood qualities. While homebuyers purchasing assets in the
more prosperous central neighborhoods pay the lowest interest rates, those
purchasing assets in the peripheral and economically weak neighborhoods pay the
highest ones. Observable characteristics of the borrower, the mortgage and the
underlying asset risk, and banking competition explain up to two thirds of the
regional and socioeconomic differences in mortgage interest rates found in the
raw data. Other factors that may explain remaining regional differences in the
interest rates include unobservable borrower characteristics such as financial
literacy and bargaining ability, unknown characteristics of borrower's
employment and statistical discrimination of some groups of borrowers.