You have a mortgage which seemed perfect at the time you financed the property, but times have changed. Interest rates may be lower, the variable rates that were attractive at the time you took the mortgage may now be significantly higher, your financial picture may be different or you may have found that the terms of the current mortgage are no longer the most beneficial for you.
In this article, I will discuss some of those scenarios and review the various refinancing options available.
Refinancing a mortgage is done when a current mortgage holder makes a decision to pay off the current mortgage and replace it with a new mortgage.
The rationale behind refinancing can vary, and include the following;
- Lowering the overall cost of the mortgage
- Lowering the monthly payments on the mortgage
- Changing the makeup of the product mix
- Changing the terms of the mortgage
A refinance can be done with any one of these goals in mind or a combination.
Lowering the Overall Cost of the Mortgage
Every borrower would like to have the ability to lower the overall cost of their mortgage. This opportunity would most often present itself when interest rates are significantly lower than they were at the time that the original mortgage was taken.
However, in Israel fixed mortgages are subject to pre-payment fees, which are calculated to offset the loss in interest that the banks might incur when a mortgage is paid off early.
Nevertheless, Bank of Israel regulation requires that banks discount that calculation by 20% after 3 years and 30% after 5 years. Thus, after 3 years it may still prove beneficial to refinance a fixed rate mortgage if rates have fallen significantly.
Another means of lowering the overall cost of a mortgage is to shorten the life of the mortgage. Doing this would lower the amount of interest paid over the life of the mortgage – thereby lowering the overall cost. The disadvantage of this method is that monthly payments will increase.
As an example, if one has 25 years left on NIS 1 million in principal at a fixed rate of 4%, the overall interest cost till the end of the term would be approximately NIS 583,000, while the monthly payments would be NIS 5,278.
If this mortgage was refinanced to 15 years, even at the same 4%, the total interest to be paid would be approximately NIS 331,000 – a savings of NIS 250,000. In this case, the monthly payments would increase to NIS 7,397 per month.
If a borrower’s income has increased sufficiently to afford the higher monthly payments, there is a significant amount of money to be saved!
Lowering the Monthly Payments on the Mortgage
Borrowers often find themselves in situations where they are faced with monthly mortgage payments that are too high for their liking, either because the interest rates on the existing mortgage are higher than current rates or a change in their financial situation has made the payments too large a burden.
In the case where rates are deemed too high, the main issue will be to clarify if indeed lower rates can be achieved AND whether the current mortgage is subject to prepayment fees.
If prepayment fees are applicable, a review can be made comparing the total cost of continuing with the current mortgage as opposed to paying off the current mortgage and refinancing it with a new lower rate mortgage.
In the event the borrower’s financial situation would make lower monthly payments attractive, the borrower can look to refinance and increase the length of the mortgage term.
As an example, if the current mortgage has a 1 million shekel balance with 15 years left at 4%, the monthly payments would be NIS 7,397 per month. If they refinanced the 1 million shekel balance to a 30 year mortgage at the same 4%, they would lower the monthly payments to NIS 4,774 per month.
Changing the Makeup of the Product Mix
In Israel, it is quite common to take a mortgage that is made up of various products. A review of these products can be found in the article Israel Mortgage Primer – Mortgage Products.
While the product mix might have been the most appropriate at the time, this might no longer be the case.
For instance, a common mix might include one third of the mortgage at fixed rates (which is a minimum requirement of the Bank of Israel), one third linked to the Prime Rate and the balance one third linked to an interest rate that is set for a specific period and then resets at fixed periods (often between one and five years).
Commonly, the fixed rate was the highest rate, but it was locked in for the entire term of the mortgage. The portions linked to the Prime Rate and interest rates may have been significantly lower, bring down the overall cost of the mortgage.
And that was fine when interest rates were low and stable. But now you might be concerned that interest rates are rising and may be at risk for higher monthly payments. In order to avoid that possibility, you might consider refinancing the portions of the mortgage that are linked and converting them to a fixed rate.
Another alternative is that your product mix may have included more that one third at a fixed rate and now you believe that interest rates are likely to decrease.
By refinancing the portion that is more than one third fixed (the minimum required by Bank of Israel regulations) and converting it to products that are linked to interest rates, you can potentially benefit if, in fact, interest rates do decline.
Changing the Terms of the Mortgage
While interest rates are indeed an important aspect of any mortgage, there are other terms of a mortgage that can play equally important roles.
In this regard, the length of the mortgage is one facet that has considerable impact on the overall cost of the mortgage, and as discussed above, shortening the time frame of the mortgage can significantly lower the overall cost of the mortgage. But there are other terms that might be the impetus for refinancing as well.
When the original loan was obtained, it is possible that a cosigner was needed in order to qualify. There may be many reasons why it might be beneficial to remove the co-signer from those obligations, and assuming that the borrower is now able to qualify for the mortgage on their own, they could apply to have the mortgage modified to release the co-signer from their obligations.
Generally speaking, the banks will require that a borrower take out a life insurance policy to cover the principal balance of the mortgage.
At the early stages of the mortgage, the cost of the policy might not be unreasonable. However, there may be a point in time when the cost does become excessive. It is possible to apply and receive a waiver of life insurance, under certain circumstances.
The Refinancing Process
The process for refinancing a mortgage involves much of the same requirements as applying for a new mortgage. The bank will want to review the borrower’s financial standing and will apply the same standards for eligibility as discussed in the article Israel Mortgage Primer – Before You Apply. Funding requirements will be similar as those needed for a mortgage covering a purchase, as reviewed in Israel Mortgage Primer – Documentation.
If the refinancing is done at the same bank where the current mortgage exists, the process will be shorter. However, refinancing at a new bank may prove to be worth the additional time and effort involved.
Next up in the series: Why use a mortgage broker?
Prior post in the series: What will be required in order to fund the mortgage and pay off the seller?
The author, Norman Shapiro, lives in Israel and is available for consultations during regular business hours in Israel as well as evenings to accomodate foreign clients. He may be reached at email@example.com or you are welcome to schedule an appointment at this link.