2022 has been an extremely difficult year for borrowers with variable-rate mortgages. After nearly 8 straight years of paying about 1.5%, mortgage holders have been hit by 6 consecutive rate hikes and are now paying closer to 4.25%. This is a big deal. On a 30-year loan, this leads to an approximate 40% increase in the monthly repayment.

Thanks to prudent lending restrictions in Israel enacted about 10 years ago, many borrowers are only seeing the interest rate change affect a small portion of their mortgage, as most of their loan is set at fixed or semi-fixed mortgage rates. Nonetheless, most of the country is seeing at least part of their mortgage repayments increase, and together with a general cost of living crisis, this is unquestionably causing many families a lot of financial pain.

So why not just refinance your variable-rate loan into a fixed-rate loan? Whilst this seems like an intuitive solution, this may mean that you are making your cash flow problem worse by locking in at a higher interest rate than you are currently paying. This can make the short-term cash flow problem even worse, whilst simultaneously opening you up to a risk of pre-payment penalties, which only apply to fixed-rate loans but not variable-rate loans. 

In my opinion, there is no one-size-fits-all solution to this crisis, but below are 5 tips that can help you move forward during the current mortgage crisis in Israel in an informed way.

1. Pay down part of the loan

Not everyone has the ability to do this, but paying down the variable section of your mortgage can be a very effective means of improving monthly cash flow, especially as there are no prepayment penalties for doing so. Whilst previously it didn’t make sense to pay down loans that cost less than the inflation rate, as borrowing costs increase the comparative advantage to investing the money elsewhere also shrinks. Why invest funds at a 4% return if you are paying 4.5% on your mortgage debt?

2. Refinance before payments bounce, not after 

Although this seems obvious and banal, it’s hard to overstate how important this is. If your cash flow situation is difficult but your credit history is good, the bank will happily refinance your loan in order to improve your cash flow. But if you react too slowly and approach the bank with a recent history of bounced checks and returned direct debits, they may be unwilling to allow you to refinance. Usually, you can tell your bank that if they don’t give you what you will go to a different lender, but this threat won’t work well if your repayment history isn’t good, as other lenders may not want to lend to you. So make sure you stay ahead of the curve.

3. Where do you think rates are going?

When refinancing, the key question is not what mortgage rates have done in the past, but what you think they will do in the future. If you believe that global inflation and the energy crisis will soon come under control, it is unwise to lock in long-term fixed rates when they are relatively high. If you believe that interest rates are finally starting to return to more normal levels and the era of cheap money is over, you should be much more inclined to fix rates now, before they rise further.

Interestingly, nowadays the interest rate on a 3-year fixed-rate loan is not much less than the interest rate on a 30-year fixed-rate loan. This is historically unusual and tells us that the market thinks that although rates may be high at the moment, they will not likely rise much above current levels. 

I’m not saying the market is always right, but the aggregate wisdom of many very clever people does seem to be that long-term rates are not about to start spiraling upward.

4. Extend the loan term

If you want to lower your monthly repayment without the risks involved in fixing a rate, you can extend the variable rate mortgage term. This can be done and undone without incurring any prepayment penalty and is a very simple way of helping cash flow without any significant long-term consequences.

5. Fix the rate

Although we’ve left this one till last, it really is the most powerful of the lot. A fixed-rate mortgage, set for the right number of years, is an extremely powerful tool to manage cash flow, as the monthly repayment does not change at all as the loan matures. As discussed, it does come with the risk that you are fixing at a high rate, and there is a risk of a pre-payment penalty, nonetheless, on balance, this may be the best way to weather the current storm.