How does the bank set the mortgage interest rate?
Banks, as you know, are not non-profits but business entities that want to make money. And so – when the bank gives us a mortgage, it charges a certain interest rate on it, derived from a number of parameters.
The bank has profitability targets it wants to achieve on mortgages. These targets can vary from bank to bank, over time within the same bank (they can be one thing today and something else in a few months) and sometimes even between different regions of the same bank (that is – the North region will have different targets than the Center or South region. Rarer, but it can happen).
What is the bank's profitability on a mortgage?
It's important for us to understand that the bank doesn't hold the money it lends us in a current account. It raises this money itself. It can come from our deposits, it can come from a loan it takes from the Bank of Israel, it can issue bonds, and in many other ways. In effect – the bank buys the money, adds two parameters on top of it and then sells it to us. What are the parameters? The first is what the bank calls "operating costs". These costs are fixed for all mortgage tracks, and through them the bank essentially factors in its overhead: what salaries, branches, etc. cost it. The second is the profit the bank wants to make on the money it sells us.
Something else that's important – the spread is a function, in addition to the bank's targets, of the quality of the customer, the quality of the property, the type of loan (for housing, for any purpose), the financing percentage, and whether or not the customer is a customer of the bank. And so – the mortgage one person gets is not the same as the one another person gets.
Bottom line – the interest rate we get equals funding costs + operating costs + profit.
As for the profit – the bank divides the profit into two parts: the profit on each mortgage track separately and the total profit on the mortgage.
After all, as we've already discussed in the past – our mortgage will usually be divided into several tracks.
For example – fixed unlinked, variable unlinked and Prime.
For each of the tracks separately the bank has a profitability target.
When the banker enters the track's data into their computer – they see the spread, and if they give us an interest rate that is too low relative to what the bank has defined for them on that specific track – it will alert them.
In addition – after they finish entering the data for all the tracks – the system also shows them the total spread of the mortgage. If one of the tracks has a spread that's too low but another track has a high spread – they can send the mortgage for approval (which sets us up for the next article – how we can use this to our advantage). If the total spread is also too low – they will need a higher authority and a special explanation of why they want to push through such a mortgage.
What does this look like in practice?
The easiest way to explain it is through the Prime rate:
Many of us take part of the mortgage in a Prime track. And then we get: "Prime minus a half", "Prime minus 0.8" and so on. On this track – the anchor for calculating the interest is Prime, and the bank, in housing loans to good borrowers, will usually sell us the money for less than Prime.
Another place where we see the spread: in the variable-rate tracks. In the examples on the left: the tracks are very similar. One of them is variable unlinked every year and a half and the other is variable unlinked every two and a half years. You can see that in the first – the spread from the anchor is 0.17, while in the second it is 0.3. The anchor in both cases is the yield on the State of Israel bond for the corresponding bond (an unlinked bond for a year and a half or for two and a half years). Of course, the bank's profit on the left mortgage is higher than on the right one, for this specific track.
Something that's important to understand – the mortgage advisor, the banker or anyone else – has no influence on the anchor. No influence on what the Prime rate or the bond yield will be. Only on the spread from the anchor, from which, as mentioned, the bank's overall profitability is derived. At the time of writing this article (end of 2024), bond yields as well as the Prime rate are relatively high, and so it's often possible to get low spreads. Why is that good? Because in X amount of time, when bond yields and Prime come down (and I hope they do come down) – mortgages taken today will become very cheap. On the other hand – those who took a mortgage in a period of very low yields often got relatively high spreads, and then at the next interest-rate change point – the monthly payment may jump significantly.
So next time you're sitting in front of the banker – ask her what spread you have on each track. Tell her that another bank offered you much lower spreads. She probably won't cooperate with you 100%, but she'll see that the person sitting in front of her knows what they're talking about and that you can't just push a high price on them.
Good luck,
Gad