Prime Interest Rate and Its Effect on Your Mortgage

Prime interest rate is one of the most important concepts in the world of mortgages, loans and household financial management. Almost everyone who takes out a mortgage, checks a loan or compares financing tracks comes across this term at some point. Despite this, it is not always clear what prime interest rate is, how it is determined, why it changes, and how it actually affects the monthly repayment.

In simple words, prime interest rate is a benchmark interest rate used for pricing loans, mortgages, credit facilities and sometimes deposits. When talking about a prime track in a mortgage, it means a track where the interest rate changes according to changes in the prime rate. Therefore, when the prime interest rate increases, the repayment on such a track may also increase. When it decreases, the repayment may decrease accordingly.

What Is the Prime Interest Rate?

Prime interest rate is an interest rate based on the Bank of Israel interest rate plus a fixed margin that is customary in the banking system. In practice, it is used as a benchmark rate on which various financial products are based, including loans, mortgages and credit facilities.

When a loan is quoted at an interest rate of prime minus half, it means that the interest on the loan will be half a percent lower than the prime interest rate. When you say prime plus one percentage point, it means that the interest rate will be one percent higher than the prime rate. Therefore, it is not enough to know what the prime interest rate itself is. It is also important to understand what the margin is that is added to it or subtracted from it.

Prime interest rate is not a fixed interest rate for the entire loan period. It can change over time according to changes in the Bank of Israel interest rate, so it is considered a variable interest rate.

How Is the Prime Interest Rate Calculated?

The conventional calculation of prime interest rate is relatively simple: Bank of Israel interest plus 1.5 percentage points. For example, if the Bank of Israel interest rate is 4%, the prime interest rate will usually be 5.5%.

However, it is important to remember that the number itself can change. The Bank of Israel interest rate is updated from time to time in accordance with monetary policy, inflation, economic conditions, the labor market, economic activity and other factors. When the Bank of Israel interest rate changes, the prime rate changes accordingly.

This is why a prime mortgage track is considered a dynamic track. It may be attractive in certain periods, but may also become more expensive when the interest rate environment rises.

How Does the Prime Rate Relate to the Bank of Israel Interest Rate?

The Bank of Israel interest rate is the main interest rate that affects the cost of money in the economy. When it rises, the cost of credit usually rises. When it goes down, the cost of credit may go down. The prime interest rate is derived from it, so it is directly affected by it.

This connection is especially important for borrowers who have a loan or mortgage in a prime track. A change in the Bank of Israel interest rate can feed through to the prime interest rate, and from there to the monthly repayment. This means that those who chose the prime track should be prepared for the fact that their repayment is not necessarily fixed throughout the entire loan period.

On the one hand, when interest rates go down, a prime track can lower the repayment. On the other hand, when the interest rate increases, the repayment may increase and burden the monthly budget.

The Prime Interest Rate in a Mortgage

The prime track in a mortgage is one of the most popular tracks in the mortgage mix. In this track, the interest rate is not fixed in advance for the entire loan period, but changes according to the prime interest rate. Usually, the offer will be presented in the form of prime minus a certain margin or prime plus a certain margin.

The main advantage of a prime track is flexibility. It is not indexed to the consumer price index, therefore the loan principal does not increase due to indexation. In addition, in such a track, it is sometimes easier to make an early repayment or refinancing, in accordance with the terms of the loan agreement.

However, flexibility comes with risk. The monthly repayment may change over the years, and sometimes the change can be significant. Therefore, a prime track can be an important tool in the mortgage mix, but it is not always advisable to base too large a part of the loan on it without understanding the consequences.

The Benefits of a Prime Track

The first advantage of a prime track is that it is not linked to an index. This means that the loan principal does not increase because of an increase in the consumer price index. For borrowers who want to avoid CPI indexation, this is a significant advantage.

The second advantage is the possibility of benefiting from a decrease in interest. If the prime rate goes down, the repayment on the track may go down accordingly. In times of falling interest rates, a prime track can be more advantageous than other tracks.

The third advantage is flexibility. In many cases, the prime track is considered a track that is generally easier to modify, repay early, or refinance, but it is important to check this according to the specific loan conditions.

The fourth advantage is relative transparency. It is easy to understand what the interest consists of: prime interest rate plus or minus a certain margin. It is therefore easier to track changes in the interest rate and understand why the repayment has changed.

The Disadvantages and Risks of the Prime Interest Rate

The main disadvantage of prime interest rate is the uncertainty. Because interest rates fluctuate, the monthly repayment can go up or down over the years. When the interest rate environment rises, borrowers in the prime track may feel the change quite quickly.

Another disadvantage is the difficulty in long-term planning. In a mortgage spread over many years, even a small change in the interest rate can affect the monthly repayment and the total cost of the loan. That is why it is important to examine not only the repayment at the beginning, but also scenarios in which the interest rate increases.

In addition, a prime track may seem very attractive when interest rates are low, but become less favorable when interest rates change. Those who choose such a track should check whether the family budget is able to withstand a higher repayment in the future.

Prime Minus and Prime Plus: What Do They Mean?

When you receive an offer for a prime track, the interest rate will not always be exactly the prime rate. Usually it will be presented as prime minus or prime plus.

Prime minus means that the interest rate is lower than the prime rate by a certain margin. For example, if the prime rate is 5.5% and the offer is prime minus 0.5%, the actual rate will be 5%.

Prime plus means that the interest rate is higher than the prime rate by a certain margin. For example, if the prime rate is 5.5% and the offer is prime plus 1%, the actual interest rate will be 6.5%.

The margin itself is very important. Two borrowers can take out a prime loan, but pay a completely different interest rate because of the margin set in the offer. That's why when comparing offers, you don't just check if it's a prime track, but also what the exact margin is in relation to the prime.

How Does the Prime Interest Rate Affect the Monthly Payment?

The effect of prime interest rate on the monthly repayment can be significant. When the prime rate goes up, the interest on the prime track goes up, so the monthly repayment may go up. When the prime rate goes down, the repayment may go down.

For example, if a significant part of the mortgage is in the prime track, a one-percentage-point increase in interest may increase the monthly repayment in a noticeable way. The higher the loan amount and the longer the repayment period, the greater the impact of the interest rate change.

That's why it's important not to choose a prime track based only on the current monthly payment. You also need to check what will happen if the interest rate rises, how it will affect the budget, and whether there is an ability to deal with such a change without causing financial strain.

Is the Prime Interest Rate CPI-Linked?

No. The prime track in the mortgage is not linked to the consumer price index. This is one of its main advantages. When there is inflation and the price index rises, the loan principal in the prime track does not increase because of the index.

However, the fact that the track is not index-linked does not mean that it is risk-free. The main risk in it is a change in interest rates. In other words, the principal is not linked to the index, but the monthly repayment can change due to a change in the prime rate.

That is why it is important to distinguish between two types of risk: CPI-indexation risk and interest rate change risk. A prime track reduces the linkage risk, but leaves the borrower exposed to interest rate changes.

How Much of a Mortgage Should Be in the Prime Track?

There is no one answer that fits all. The appropriate proportion of a mortgage allocated to the prime track depends on repayment capacity, the level of risk the borrower is willing to take, the level of income, economic stability, the term of the mortgage and the other tracks in the mix.

In general, a prime track can be an important component in the mix, but it is important to combine it in a balanced way. A well-designed mortgage mix is not built according to the track that seems the cheapest on the day of signing, but according to a combination of cost, stability, flexibility and the ability to meet changing scenarios.

In addition, there are general restrictions on the structure of the mortgage mix, so it is impossible to build any mix you want without taking into account the rules that apply to tracks with fixed interest and variable interest.

Prime Interest Rate on Non-Mortgage Loans

Prime interest rate is not only relevant to mortgages. It is also used in loans for any purpose, consumer loans, credit facilities and sometimes other financial products. Even in these cases the interest rate can be shown as prime plus or prime minus.

With shorter loans, a change in the prime rate may be less dramatic than with a longer-term mortgage, but it's still important to understand the impact. If the loan is taken at a variable interest rate based on prime, the monthly repayment may change during the period.

Therefore, even in non-mortgage loans, it is important to check what the actual interest rate is, what the margin is relative to the prime rate, whether the repayment is fixed or variable, and what will happen if the prime interest rate rises.

When Can a Prime Track Be Suitable?

A prime track can suit borrowers who understand the risk, are able to deal with a possible change in the monthly repayment and want to incorporate a flexible track that is not linked to the index into the mix.

It may be particularly suitable when you want to maintain the possibility of early repayment, when you want to reduce exposure to the index, or when you want to integrate a variable component within a broad and balanced mix.

However, a prime track is less suitable for those who require absolute certainty in the monthly repayment, for borrowers for whom even a small payment increase may be burdensome, or for those who do not want to be exposed to changes in the interest rate environment.

What Should You Check Before Choosing a Prime Track?

Before choosing a prime track in a mortgage or loan, it is important to check some key points:

• What is the current prime interest rate at the time of receiving the offer?
• Is the offer prime minus or prime plus?
• What is the exact margin in relation to the prime rate?
• What part of the mortgage is in the prime track?
• What will happen to the monthly repayment if the prime rate goes up?
• Is the repayment also suitable for the scenario of an interest rate increase?
• Is the track combined with more stable tracks?
• Is there too much exposure to variable interest?
• Is it possible to make early repayment or refinancing under favorable conditions?
• Is the track suitable for the family's financial planning in the coming years?
• Is the entire mix balanced and not based only on an interest rate that seems favorable today?

Such an assessment makes it possible to understand not only the current monthly payment, but also what the future risk is and what the level of flexibility of the loan is.

Common Mistakes When Choosing a Prime Track

The first mistake is to look only at the initial repayment. A low initial repayment can be tempting, but if interest rates rise, the repayment may change.

The second mistake is to think that a track that is not linked to the index is a track without risk. A prime track is not linked to the index, but it is exposed to interest rate changes.

The third mistake is to choose too large a part of the mortgage in the prime track without checking future scenarios. The larger the portion in the prime track, the more sensitive the total repayment is to interest rate changes.

The fourth mistake is not comparing the margin from the prime rate. Sometimes two offers look similar, but in practice the difference in the margin can affect thousands of shekels over the years.

The fifth mistake is to build a mix according to today's interest rate situation only, without thinking about the future. A mortgage is a long-term commitment, so you should also examine periods when the interest rate may be higher.

How Should the Prime Track Be Combined in a Mortgage Mix?

A proper allocation to the prime track in a mortgage mix should be done as part of overall planning. The goal is not to choose the track that seems the cheapest at that moment, but to build a mix that fits the ability to repay, the level of risk, the term of the mortgage and the family plans.

A balanced mix can combine more stable tracks with more flexible tracks. A prime track can provide flexibility with no CPI indexation, but it should be balanced with components that provide higher stability in repayment.

In addition, it is important to check the mortgage over the years. Even if the prime track was suitable on the day of taking out the mortgage, it may later be appropriate to refinance the mortgage, change the mix or adapt the loan to changes in income, expenses or the interest rate environment.

Summary: The Prime Interest Rate Is an Important Tool—Use It Wisely

Prime interest rate is a central concept in the world of mortgages and loans. It affects many financing tracks, the monthly repayment and the borrower's risk level. Its main advantage is flexibility and the lack of CPI indexation, but the main disadvantage is exposure to interest rate changes.

A prime track can be an important part of the right mortgage mix, but it should not be considered alone. It is important to check the margin from the prime, the repayment amount, the risk of interest rate increases, the other tracks in the mix and the family’s financial capacity to deal with changes.

In the end, choosing a prime track is not a question of good or bad, but a question of fit. When you understand how the prime interest rate works, what affects it and the risk it creates, you can use it in a smarter way and make a more accurate and safer financial decision.