You Should Not Sacrifice the Study Fund (Keren Hishtalmut) for a Cheaper Mortgage
There's something frightening about mortgage debt. We've never been overdrawn, we've only heard about overdrafts in stories, and the thought of owing an enormous sum to the bank is a little scary. A mortgage loan brings uncertainty and plenty of worries. It's stressful to commit to a large repayment over such a long period. Who's to say we'll always have a job and a paycheck?
Luckily, our uncle signed his own mortgage papers just a month ago, learned everything there is to know, and has the perfect solution for us. We have a study fund (keren hishtalmut), right? And in four more years it becomes liquid, right? So he's got a fantastic idea for us. Once the fund is liquid (meaning we can withdraw money from it), we'll pull out all the money and use it to make an early prepayment on one of our most expensive loans.
On the face of it, this seems like the logical, sensible thing to do — after all, it's a safe way to cut the debt. But this move could turn out to be one of the biggest financial mistakes we ever make.
📚Enrichment paragraph: a brief background on the advantages embedded in study funds (keren hishtalmut)
A study fund (keren hishtalmut) is one of the best financial products available to us as investors. Its advantage comes from the fact that gains in the fund are exempt from capital gains tax.
Capital gains tax is a tax on the profit from selling an asset for more than you paid for it — shares, real estate, or investment funds, for example. (net of inflation)
All the gains our fund earns will be tax-exempt. The catch is that we can only withdraw funds six years after the first deposit — or three years after the first deposit, if we've already reached retirement age. (Under Section 16 of the Income Tax Ordinance)
Let's focus on this exemption for a moment. Suppose we have an investment portfolio on the stock exchange (that is, not in a study fund) that held 100,000 NIS at the start of the year. Suppose we invested wisely and ended the year with a 4% gain, bringing the portfolio's value to 104,000 NIS. This gain is before tax, so in everyday language we'd call it a "gross" gain.
Now we want to sell the portfolio. The moment we sell, a "taxable event" occurs, meaning we owe tax on the gains we made. Recall that the gain is 4,000 NIS, or 4%. Capital gains tax currently stands at 25% of the gains (in the general case) under Section 91 of the Income Tax Ordinance. In other words, we have to pay the state 1,000 NIS — 25% of our gain.
So our gain is 3,000 NIS — a net return of 3% on our initial capital of 100,000 NIS. The gross return is 4%, but after taxes our net return is 3%.
Why does the study fund (keren hishtalmut) have a return advantage over direct investment in the capital market?
Now let's run the same exercise — with a study fund (keren hishtalmut):
At the start of the year the fund held 100,000 NIS, and it ended the year with a 4% return, or 4,000 NIS. Suppose the fund is liquid, so we can withdraw the funds. That means we can withdraw 104,000 NIS without paying any capital gains tax on the money in the fund! In other words, with a study fund (keren hishtalmut), what you have is what you get. A 4% return is a 4% return! The net return equals the gross return.
And here's the important part. To get that same 4% net return from the capital market that the study fund delivers, we'd need a portfolio yielding 4% × 1.33 = 5.33% — because that's what would leave us with a 4% net return after capital gains tax.
That's the great advantage of the fund — its return is "multiplied" by 1.33!
If we examine (by using the Gemelnet website) the performance of the leading study funds with the highest average return over five years, we see that the average annual return ranges between 5% and 8% (depending on the period). We deliberately based the calculation on the average of the thirty best funds (roughly 20% of all active study funds), to show that on average, a high return is achievable over time.
Just to put it in perspective: to net a 6% return in the capital market, we'd need a gross return of 7.98% — and that's not easy to hit consistently.
Why it is a financial mistake to redeem the study fund (keren hishtalmut) in order to get a cheaper mortgage:
Now it's time to put our uncle's proposal to the test, using an example based on a real mortgage offer.
Let's look at the hypothetical mortgage offer received by Yoni and Michal (fictitious). Suppose the property value is 1,430,000 NIS and the required mortgage amount is 1,072,000 NIS — meaning the LTV stands at 75%.
| Loan Track | Rate | Term | Loan Amount | Monthly Payment | Total Interest Payments |
|---|---|---|---|---|---|
| Variable rate loan unlinked CPI (MALATZ) | 4.40% | 30 years | ₪ 353,000 | ₪ 1,767.69 | ₪ 283,366.96 |
| Fixed unlinked (KALATZ) | 4.20% | 20 years | ₪ 366,000 | ₪ 2,256.65 | ₪ 175,595.73 |
| Prime-linked | 5% | 30 years | ₪ 353,000 | ₪ 1,894.98 | ₪ 329,192.92 |
| Total | 4.52% | 26 years and seven months | ₪ 1,072,000 | ₪ 5,919.32 | ₪ 788,155.62 |
First, let's calculate the weighted average interest rate of this mortgage mixture. It comes to 4.52% (you can see how to calculate it below). That means our interest payments on this loan will be 4.52% of 1,072,000 NIS, or 48,454 NIS in the first year. In theory, the interest payments will drop from year to year, because the outstanding principal balance (our bank debt) shrinks.
📊Click here to learn how to calculate the weighted average interest rate and the weighted average loan duration
Calculating the weighted average interest rate
To calculate the weighted average interest rate of the mortgage mixture, we multiply each loan track's interest rate by its weight (its share of the total mortgage) and add up the results.
Variable rate loan unlinked CPI (MALATZ):
Fixed unlinked (KALATZ):
Prime-linked:
Total:
Calculating the weighted average loan duration
To calculate the weighted average loan duration, we multiply each loan track's term by its weight and add up the results.
Variable rate loan unlinked CPI (MALATZ):
Fixed unlinked (KALATZ):
Prime-linked:
Total:
Let's assume Yoni and Michal have a study fund (keren hishtalmut) that achieves, over five years, the average return of the thirty best study funds. Let's also assume the study fund is liquid and holds 100,000 NIS, and that Yoni and Michal's employers deposit 2,000 NIS a month into their study funds.
We'll work through each of the main options available to Yoni and Michal and show which one is financially better for them:
Option one: redeeming the study fund (keren hishtalmut) and taking a smaller mortgage of 972,000 NIS.
In this scenario, the study fund (keren hishtalmut) is cashed out in full. The employers set up new study funds for Yoni and Michal, into which 2,000 NIS is deposited each month. The amount they need to borrow from the bank drops by 100,000 NIS, to 972,000 NIS.
We'll present the data two ways.
Here's the first way — the wrong one. In this approach, we "color" the money, keeping two accounts in our head: an investment account and a debt account. This is called mental accounting.
Mental accounting is a behavioral bias in which people sort money into separate mental categories and make different decisions about each one, contrary to the principle that every shekel is worth the same. It leads to irrational financial decisions — like happily spending an "unexpected windfall" while carefully guarding savings of exactly the same amount.
Richard Thaler, an American economist at the University of Chicago, coined the term and developed the theory as part of his work on behavioral economics. For his research in the field, including mental accounting and "Nudges," he was awarded the Nobel Prize in Economics in 2017.
On the liabilities side, the mortgage debt (the blue graph) shrinks over the years. The money in the study fund (keren hishtalmut), by contrast, grows. By year thirty, if Yoni and Michal don't touch their study fund again, it will hold 1,726,000 NIS.
Study Fund Accumulated Value and Mortgage Outstanding Balance as a Function of Time
Now let's look at the picture holistically — our consolidated financial position. We take the value of our assets (the money in the fund) and net out our liabilities (the outstanding mortgage principal). It makes sense to look at it this way, because the split between assets and liabilities exists only in our heads.
Total Net Economic Value — Total Assets Less Total Liabilities — as a Function of Time
At first, we're deep in debt — almost a million NIS — which is gradually offset as the years pass. At the same time, we hold an asset that keeps growing: the study fund (keren hishtalmut).
Now let's see what happened in option two.
Option two: we leave the study fund (keren hishtalmut) untouched and take a mortgage of 1,072,000 NIS.
In this scenario, Yoni and Michal don't touch the study fund (keren hishtalmut). They carry a larger debt but hold a fund worth 100,000 NIS.
Study Fund Accumulated Value and Mortgage Outstanding Balance as a Function of Time
Let's look at the consolidated analysis. Yoni and Michal start in deeper debt, but at the end of the mortgage their net asset balance stands at 2,188,000 NIS!
Total Net Economic Value — Total Assets Less Total Liabilities — as a Function of Time
Let's sum up the data in a table:
| Option A - Redeem the study fund (keren hishtalmut) | Option B - Do not redeem the study fund (keren hishtalmut) | |
|---|---|---|
| Initial mortgage amount | 972,000 ₪ | 1,072,000 ₪ |
| Study fund (keren hishtalmut) size at start | 0 ₪ | 100,000 ₪ |
| Total assets at end of mortgage | 1,726,165 ₪ | 2,188,403 ₪ |
| Difference | 462,238 ₪ more in Option B! | |
What's going on here?! Does it make sense that redeeming the study fund (keren hishtalmut) leaves us with less money at the end?
Leaving the fund alone is the better financial move, for a couple of reasons:
- The return on the study fund (keren hishtalmut) is higher than the interest rate on the mortgage mixture.
- The strongest force in the universe (according to Albert Einstein) — compound interest — works on more money. If the fund returned 5%, then by leaving it alone we'd turn 100,000 NIS into 5,000 NIS of profit that keeps working for us the following year too. When we cash the money out instead, no profits are left to work for us in the years ahead.
Why do we choose to redeem our study fund (keren hishtalmut)?
We haven't really said anything new here. We know that if our investments earn a return greater than the cost of our liabilities, then holding on to those investments leaves us with more money in the end.
Still, for many people it's hard to carry a larger mortgage when there's money on hand to pay it off. So how do we explain the pull toward such an illogical, irrational move?
We can turn to Prospect Theory to answer the questions above.
Prospect Theory is a theory in behavioral economics holding that people evaluate gains and losses asymmetrically — the pain of a loss is felt twice as intensely as the pleasure of a gain of the same size. It explains behaviors like holding losing shares too long or selling winning shares too early.
Daniel Kahneman and Amos Tversky developed the theory in their groundbreaking 1979 paper, which became one of the most cited papers in economics and laid the foundations for the field of behavioral economics.
Prospect Theory helps us understand why people act against their financial interest and redeem the study fund (keren hishtalmut). It shows that we prefer a certain outcome (cutting the mortgage debt) over an uncertain one, even when the uncertain one is better on average (continuing to grow our savings in a study fund).
Prospect Theory
The pain of losing ₪100 is felt more intensely than the pleasure of gaining ₪100.
Based on research by Kahneman and Tversky (1979)
How do you make a sound financial decision? Does the study fund (keren hishtalmut) have a role in our mortgage?
In our humble opinion, only three goals justify dipping into the study fund (keren hishtalmut):
A. Financial catastrophe — you've been laid off, you're ill, you're facing a huge expense, or you're in a chronic cash-flow deficit.
B. Future help for the kids — it's nice to know that even now you're saving for the home they'll want to buy in twenty years.
C. Improving / raising the quality of life in senior years
Notice that we defined goals or events that are decades away. That's intentional — we want to let the tax benefit work for as long as possible. A gain you earned this year, and paid no tax on, is a gain that will compound in the years ahead.
Our mortgage debt is a long-term debt — a thirty-year one. We can think of the study fund (keren hishtalmut) as long-term saving. Take that view, and the chance of coming out behind is very low.
Good luck!