Mortgage Crisis Looming, Bank of Israel Warns

Too many borrowers are committing themselves to excessive monthly payments that could lead to widespread defaults, a study has found.

Israel's mortgage market is at risk of collapse in the event of a major economic downturn, a study released on Sunday by the Bank of Israel warned.

The average monthly mortgage repayment as a percentage of household income has risen sharply to 31%, up from 23% three years earlier – a rate that is exceptionally high by international standards.

If housing prices continue to rise at their current levels, that figure could climb to 34%, the central bank warned.

The percentage of total mortgage repayments made by Israelis exceeding 40% of household income – a threshold the Bank of Israel said it regards as high risk – has reached a record high of 17%. Four years ago, the figure was just 12%, the central bank said.

Another worrying trend, it said, was that new mortgages are being taken for longer repayment terms, which increases the risk borrowers are assuming even more.

"The Bank of Israel is sounding the warning bells loudly. Anyone who has taken or intends to take a mortgage would be advised to listen closely and start preparing in order to avoid experiencing a dramatic increase in monthly mortgage payments in the next few years," said Shachar Avishai, mortgage consulting manager at Excellence Investment House.

Behind the trend toward riskier borrowing is the fact that home prices jumped 54% from 2008 to 2012 while wages increased by just 20%, the bank said. As a result, mortgage repayments have ballooned in proportion to income even as interest rates have declined in recent years.

The average mortgage at the end of 2012 was NIS 580,000, compared to NIS 200,000 in 2003. The report found that as recently as the end of 2007, the average home loan was NIS 330,000, meaning most of the increase in mortgages had occurred since 2008.

The report came as the Central Bureau of Statistics yesterday reported an accelerating rise in house prices. Its housing price index rose 0.7% in August from July – more than three times the pace of overall inflation. Looking at prices over June and July, the CBS said home prices had risen 0.6% from May-June and 9.3% from a year earlier.

Risky and riskier

The Bank of Israel study, which was conducted by Golan Benita and Ziv Naor, two of the central bank's economists, explored several possible scenarios for the mortgage market.

The first assumed that housing prices will continue rising at the same rate they have over the past two years for another year before aligning with inflation. It also assumed that average household income continued growing at the same rate as in recent years, and that interest rates and inflation develop in line with expectations derived from market conditions.

In that case, borrowers' risk will likely increase due to rising housing prices and higher interest rates on the variable portions of their mortgages.

The researchers based another scenario on a repeat of the 2002-2003 recession, which was accompanied by a sharp rise in interest rates. This envisions a period of declining wages and rising unemployment. In this scenario, the report assumed that housing prices would fall, resulting in a sharp increase in defaults as other countries have experienced during a mortgage crisis.

Benita and Naor warned that this scenario entailed even higher risk since a rise in unemployment brings a major increase in loan defaults, particularly when payments are relatively steep.

Benita and Naor stressed that potential credit losses for banks have declined significantly on mortgages that were taken before prices began climbing, but in the case of a sharp rise in the rate of defaults, along with falling home prices, the banks would have difficulty foreclosing on a large number of properties.

This, they said, could lead to another sharp decline in housing prices and deepen their credit losses, which occurred during financial crises in the United States and other countries during the last financial crisis.

But Ohad Dannus, chairman of the Real Estate Appraisers Association, said he saw nothing particularly worrying in the Bank of Israel report, which simply put into numbers a self-evident fact that in a recession the rate of mortgage defaults will rise.

"What the Bank of Israel did today was very grave and irresponsible in that it commissioned an academic study to justify the limitations imposed two weeks ago by the banks commissioner on mortgage takers," Dannus said.

Banks Commissioner David Zaken ordered banks two weeks ago to stop approving mortgages with monthly payments greater than 50% of the borrower's monthly income. It was the latest in a series of moves the central bank has taken to tighten home lending.

"Interest rates will obviously remain low if we enter into a recession, and if rates rise it will result from increased economic activity and a desire to prevent inflation," he said. "In any case it seems the panic they're trying to generate is out of place. As opposed to elsewhere in the world, we're talking about a commodity suffering a shortage, and the same defaulters – and we all hope there won't be any – will still need a roof over their heads after turning over their homes. In other words the home they leave will again be used for rent."

The housing market will continue remaining stable, assured Dannus, due to the fact that housing starts are progressing at the rate of 35,000 a year as opposed to an annual growth rate of 40,000 in the number of households.

Emil Salman