Don't Take a Cheap Short-Term Loan
This article looks at the downsides of folding short-term loans into our financing program. We'll show why they're tempting to take, yet how they actually wreck the quality of the mortgage mixture and end up making the mortgage more expensive.
Buying a mortgage has a lot in common with buying bananas at the market. Either way, the seller really wants you to buy what they're selling, so they'll tempt you with an attractive discount — maybe even let you sample something — to get you to say yes. The bank just uses far more sophisticated tools. It will lure you into signing with an onboarding loan at zero interest, or some other financial perk. Here are a few examples of those perks, as of the time of writing:
- Some banks lure in new customers to move their checking-account activity over by offering an onboarding loan. This is a loan at prime minus interest (ranging between prime +0% and prime minus 1%, depending on the period) in amounts ranging from 50,000 to 75,000 NIS for a period ranging from twelve to fifteen years.
- Some banks give a signing bonus of a few thousand NIS when signing a mortgage.
The topics we will describe in this article are not limited only to onboarding loans from banks, but also to the following cases:
- Reducing the mortgage by incorporating a study fund into the financing program.
- A loan from an employer or through an employees' club, for a short period and at an attractive interest rate.
- We are buying a new home with a larger mortgage, and can carry out mortgage porting from our current home.
- Our parents have offered to help. The idea is that we take a smaller mortgage, and they give us an interest-free, non-indexed loan for a short period.
Incorporating the loans described above into the mortgage mixture may cause serious damage to your mortgage — it will end up costing more than it saves.
But there is a regulatory problem, perhaps an even larger one, with incorporating such a loan into the mixture: if this loan is outside the mortgage — you will not be able to refinance it. That is, in the event of a mortgage refinancing, you will not be able to receive money (from the refinancing bank) for this loan, and you will be tied to the bank that gave you this loan until you pay it off completely.
What is the psychological trap we fall into when we take a cheap short-term loan?
"We squeezed a loan with a really low rate into the mixture? That's got to make our mixture as cheap as it can possibly be."
Don't you just want to run off and sign? We don't know of anywhere that gives out a loan at zero interest. The trouble with every loan in a mortgage mixture is that a single number, like the interest rate, isn't enough to capture its complexity and risk.
Let's walk through an example to see why this particular loan wrecks our mortgage mixture. Suppose we need to borrow one million NIS. To keep things simple, we'll pick an arbitrary split: one third in the fixed unlinked (KALATZ) track and two thirds in the prime-linked track. We can pay only 6,000 NIS per month.
Let's say we're choosing between two possible mortgage mixtures: one with an onboarding perk and one without. Let's take a look at them. Note — these are not recommended mixtures!
First mortgage offer — without an onboarding benefit/loan:
| Loan track | Interest rate | Term | Loan amount | Monthly payment | Total interest payments |
|---|---|---|---|---|---|
| Prime-linked | 5% | 30 years | ₪ 666,000 | ₪ 3,575.23 | ₪ 621,083.52 |
| Fixed unlinked (KALATZ) | 4.4% | 16 years | ₪ 334,000 | ₪ 2,426.24 | ₪ 131,837.37 |
| Total | — | ₪ 1,000,000 | ₪ 6,001.47 | ₪ 752,920.89 | |
We used the Excel CUMIPMT function to calculate the costs.
The use of the CUMIPMT function here is for illustrative purposes only and is generally not recommended because it does not reflect external changes in the loans, such as a rise in the Bank of Israel interest rate, inflation, etc. Do not use this function to plan your mortgage!
Second offer — combined with an onboarding benefit:
| Loan track | Interest rate | Term | Loan amount | Monthly payment | Total interest payments |
|---|---|---|---|---|---|
| Prime-linked | 5% | 30 years | ₪ 566,000 | ₪ 3,038.41 | ₪ 527,827.74 |
| Fixed unlinked (KALATZ) | 4.6% | 23 years and 3 months | ₪ 334,000 | ₪ 1,951.38 | ₪ 210,434.47 |
| Prime-linked — promotional | 4% | 10 years | ₪ 100,000 | ₪ 1,012.45 | ₪ 21,494.17 |
| Total | — | ₪ 1,000,000 | ₪ 6,002.24 | ₪ 759,756.37 | |
Here too, the total monthly payment stands at 6,000 NIS per month.
What changed here?
First, we had to stretch out the fixed unlinked loan. Otherwise, we'd have blown past our target monthly payment of 6,000 NIS. Keep in mind that every year you add to a fixed-rate loan pushes its interest rate up — typically by 0.05–0.08% per year. The reason we stretched out the fixed-rate loan in particular is that the prime-linked track can't be extended any further; its term is already the maximum the Bank of Israel allows — thirty years.
Take a look at the result — the mortgage mixture with the onboarding loan costs 7,000 NIS more than the mixture without it.
Why is this onboarding loan not really a benefit?
Why does this happen? How did the version with the perk end up more expensive? We're handed a discount and somehow we pay more?
With a mortgage, every time we stretch out a loan's term, we make it more expensive. To grab the onboarding perk, we had to cut 474 NIS from the monthly payment we'd allocated to the fixed unlinked (KALATZ) loan. And because that monthly payment is now lower, we had to stretch out the loan's term — which made the fixed-rate loan more expensive.
What makes us think that a mortgage mixture with an onboarding loan is actually better?
We think that an attractive loan translates into an attractive mortgage mixture because of the framing bias. The framing bias forms a central part of Prospect Theory, developed by the late Amos Tversky and Daniel Kahneman, for which Kahneman received the Nobel Prize in Economics.
The "framing" bias causes us to ignore the full picture and focus only on something narrower. This happens because someone took care to "frame" the information in a certain way. In simple terms, we are influenced by the way things are presented to us.
The connection to our mortgage — give up the onboarding loan
In this case, the framing bias can lead us to hang our whole decision on a minor detail — which mortgage mixture comes with a perk and which doesn't.
That happens because we tend to assume a mortgage mixture with such a big discount has to be cheaper and the smarter choice. After all, there's no way a discount could actually cost us money — right?
In the same way, banks grant signing bonuses on mortgages. These benefits are engineered to make us take the bait and sign a mortgage that is not right for us.
What can be done?
Telling you to simply notice the framing bias and ignore it isn't very practical advice. What we can do is help you see the full picture.
Do not sign any offer before you have used a professional calculator that allows you to compare the real costs of the different offers.
A cheap loan (a loan from a study fund, an onboarding loan from the bank, a loan from family) is worthwhile only if it is among the longest loans in the mortgage mixture.
Good luck