How Israeli Banks Price Mortgage Interest Rates and Explain Rate Differences

When taking out a mortgage in Israel, the interest rate offered by banks is a key figure, but it reflects a complex pricing system influenced by borrower characteristics and the banks' own cost of funds. Interest rates vary not only between banks but also among different mortgage tracks such as fixed, variable, prime-linked, and CPI-linked, each with distinct pricing models and profitability for the banks. The combination of rates and the weight of each track in a mortgage package ultimately determines the total cost for the borrower.

Data from the Bank of Israel in August shows that Mizrahi-Tefahot had the highest average internal rate of return (IRR) at 5.08%, followed by Bank Hapoalim at 4.94%, Bank Leumi at 4.91%, and Discount Bank with the lowest at 4.81%. For example, Mizrahi-Tefahot charges the highest average prime rate at 4.49%, with prime loans comprising only 16% of its mortgage mix, whereas Leumi and Hapoalim offer lower prime rates (4.37% and 4.42%) with prime loans making up 25% of their portfolios. Discount Bank’s prime rate is 4.47%, with 24% prime exposure. However, a higher rate does not necessarily mean a bank is more expensive overall, as explained by Nofar Yaakov, Chair of the Mortgage Advisors Association, who notes that Mizrahi-Tefahot handles more complex and higher-risk loans, justifying higher average rates.

Mortgage advisors highlight that banks compete differently across mortgage tracks based on their internal pricing policies. Jonathan Berliner, a mortgage advisor, explains that banks may aggressively price certain tracks where their funding costs are lower, while being less competitive in others. For instance, Mizrahi-Tefahot historically prices prime loans higher and focuses on competing in other tracks, creating variation in both offered rates and the encouraged mortgage mix.

Banks’ profitability on mortgage tracks depends on their funding sources and risk management. Prime loans are often funded by low-cost current account deposits, allowing banks to offer attractive prime rates and earn net interest margins from the spread over the Bank of Israel’s base rate. Fixed non-indexed loans are priced based on government bond yields plus hedging costs and bank margins. CPI-linked loans have lower base rates but protect banks from inflation risk, ensuring stable real returns. Regulatory capital requirements also influence pricing, as riskier tracks require higher capital buffers, raising costs for banks and borrowers alike.

In summary, mortgage interest rates in Israel reflect a complex interplay of borrower risk, bank funding strategies, competition across mortgage tracks, and regulatory constraints, explaining the observed differences in rates and mortgage product mixes among banks.