You’ve worked hard and found what you were looking for. You've found an apartment that suits you and have begun negotiations with the contractor. One of the first things that will come up will be the timing of payments for the apartment. The contractor will usually offer you three options:A. Pay a lot of money today and you'll get the apartment in two years (as an example).Pay a small down payment today, and as construction progresses, make additional payments at pre-determined dates.c. Pay a deposit today and the balance upon receiving the key.The contractor's proposal to pay the majority of the money upfront includes a seemingly logical reason – if you pay today, you won't be exposed to an increase in the apartment's price due to the construction input index. When paying above One million shekels Regarding any product, especially if we don't have the money and are taking out a loan for many years, another price increase is a frightening thing. Is there a reason for this fear? Are there other factors that could cause a price increase even higher than the construction input index? This article will try to clear the fog surrounding the concept of the construction input index and show that despite the natural fear which the contractor's salesperson and the bank's mortgage salesperson will try to amplify, each for their own reasons, the monster is not so terrible. What are the construction input index and the consumer price index?Input is an economic resource used to create something else of economic value. For example: The inputs required to produce a chocolate milk cup are: water to irrigate the hay eaten by the cow, fuel to power the tractor that harvests the hay, property taxes on the barn, wages for the milkers, electricity to operate the milking parlor, and then additional inputs for the production itself (sugar, flavorings, more electricity), production, transportation, and sale.In the same way, the inputs for building an apartment are blocks, rebar, cement, labor wages, fuel, electricity, etc. Consumer Price Index Calculated based on the average prices of goods consumed by households (milk as mentioned, lettuce, tomato, DVD, and more according to the Central Bureau of Statistics). The construction input index is the average of the prices of the goods (inputs) required to build an apartment.So the contractor's logic is: if you give me the full cost of your apartment today, I'll be able to buy all the necessary iron and blocks today, and then I won't care if their prices go up. On the other hand, if you don't pay me the cost of the apartment in advance, I'll have to postpone the purchase of, for example, the doors until the final stage of the apartment, and then if the price of a door changes, I, Moshe the contractor, will be in trouble. Therefore, if you want to postpone payments, you must guarantee me that if the prices of doors and windows increase, you will compensate me for this price increase.Prepaying due to indexation can be expensive and not worthwhile.I am not currently going into all the pros and cons of making advance payments to a contractor. For additional considerations You can read about the pros and cons of early payments here. But from an economic perspective, it is worth knowing that the damage from an increase in the construction input index is often lower than the damage from early payment.Let's consider a couple buying an apartment for 1.5 million shekels and they have two options:A. 20% of the apartment's current price and 80% of the apartment's price in two years upon receipt of the keys.B. 80% of the apartment's current price, 20% in two years when the keys are handed over.That couple is not one to believe every salesperson, so they conduct their own research on the Central Bureau of Statistics website and examine the two graphs below, which compare the increase in the construction input index to the general index (Consumer Price Index).Construction Input IndexConsumer Price IndexThe Consumer Price Index and the Construction Input Price Index in 2021MonthConsumer Price IndexConstruction input price index6/20210.1%0.6%5/20210.4%0.7%4/20210.3%0.8%3/20210.6%0.5%2/20210.3%0.2%1/20210.1%-0.6%Total 20211.6%3.4%Please note that the Central Bureau of Statistics has not made it easy for us to compare the graphs; the bars in the top graph represent 0.5%, while those in the bottom graph represent 1%. Let’s move on to comparing the last few years (all percentages are approximate based on the graphs above):2013: Consumer Price Index – close to 21% year-over-year, Input Price Index 1.51% year-over-year – those who feared the Input Price Index Lost.2012: The price index was approximately 1.6%, and the input index was approximately 3.4% – those who feared the input index Earn.2011: The price index was approximately 2.1%, and the input index was approximately 3.8% – those who feared the input index Earn.2010: Consumer Price Index (CPI), approx. 2.81% | Input Price Index, approx. 41% – Those who feared the Input Price Index Earn.2009: The price index was approximately 4%, the input index was approximately 0% (!) – those who feared the input index Lost.2008: The price index was approximately 3.9%, and the input index was 3.4% – those who feared the input index Lost.Actually, why do I recommend not to fear the cost index if in most of the past years, those who feared it "profited"?The comparison between the two metrics is based on two simplifying assumptions that are not actually met in practice:A. I don’t earn anything on my bank savings other than indexation to the Consumer Price Index. This is true for short-term deposits, but it is definitely not true for savings of hundreds of thousands of shekels, such as those held by someone preparing to buy an apartment. For example, if I withdraw from a study fund—which yields a modest 5.1% per year—to make an advance payment to a contractor, the index rates above show that this is never a good idea.B. I don’t pay interest on my credit. In practice, if I add 1.51% annual interest to the Consumer Price Index, as is done with actual loans, the differences between the indices—even in years when the Input Price Index supposedly has an advantage (2010–2012)—become negligible, or the trend reverses entirely.Numerical example:Let's take the year 2012, when there was a preference for bettors on the construction input index. A couple who will be called Inputs They purchased an apartment for 1,500,000 shekels with a mortgage of 1,000,000 shekels. The couple chose to pay 80% upon signing the purchase contract and another 20% upon Entrance to the apartment A year later.The couple's total expenses this year:— Loss of indexation on 200,000 NIS (300,000 = 20%, which he would have paid the contractor anyway under the second option) for one year – 2,900 NIS.— Let’s assume that the couple’s repayment capacity is 6,000 NIS, so they took out an 18-year fixed-rate mortgage at an interest rate of 3%. Over the course of the year, they paid the bank 29,400 NIS in interest. In total, the couple will pay the bank 1,295,400 shekels For their mortgage.On the other hand, the couple known as the Meddis decided to pay the contractor 20% upon signing the contract and another 80% upon moving into the apartmentThe trading of indices looks like this:A payment of 300,000 and continued holding of 200,000 in an index-linked deposit which yielded them 2,900 shekels.A monthly saving of 6,000 shekels (they are not yet obligated to mortgage payments and therefore can save the repayment amount each month).— Upon moving into the apartment, the couple took out a mortgage to pay the remaining 80% of the apartment’s price. This 80% was indexed to the construction input index, but the couple also saved 6,000 shekels each month. To simplify the calculation, I assumed that the monthly savings did not yield any return. The mortgage the couple needed to take out was 965,900 shekels (as mentioned, the debt to the contractor was indexed, but on the other hand, the couple had accumulated Equity (added during the year). Assuming the indexed couple's mortgage will be under the same terms as the taxed couple's, their total payments to the bank will be 1,237,054 Shekels.So, should I prepay the contractor or not? Well, we saw that even in the year when there was supposedly a clear preference for paying the contractor in advance, the person who paid upon entering the apartment and absorbed most of the construction input index linkage still ended up paying less money than the one who chose "not to take a risk" with the construction input index.Many couples do not have the ability to pay a mortgage at the same time as rent, and then if they choose To pay the contractor in advance They "benefit" from higher damage – they are forced to take out a balloon loan until they move into the apartment (eviction from their current apartment). This balloon loan accrues compound interest, and thus, eventually, even on the day they move into the apartment, and not just at the end of the mortgage, they may find that they have paid more than those who chose to pay later, despite the construction input index.The example above compared two scenarios where the difference between early and late payers is only one year. In most cases, the difference is at least two years when buying an off-plan apartment. Of course, as the time period lengthens, the advantage for those who chose to pay later increases. The advantage for those paying later will grow even more if, for example, their savings over those two years cause them to fall below one of the mortgage price thresholds. For example, they will move from a loan-to-value ratio of 65% to a loan-to-value ratio of 59% of the apartment’s value.In addition to all of the above, one must also add the risk inherent in any transaction where you pay a vendor a large sum of money in advance. However, as mentioned, this has already been discussed elsewhere on this site.Why do so many people actually pay contractors in advance, paying more, and risking that if the contractor has any problems, they will have to manage without the money paid for years?Unfortunately, many people have not internalized the simple fact: There is no free advice! When you consult with a bank's mortgage officer or a contractor's salesperson, it is not free advice. Although you haven't paid directly, you will pay much more by receiving biased advice: the contractor's salesperson naturally aims for the contractor to get the money as quickly as possible (why should they pay interest to the bank if the customer is willing to pay interest to the bank instead and give them a million-dollar loan with no interest at all). The mortgage officer, of course, wants you to take out a mortgage today and not in two years (by then you might notice that there are other banks and compare conditions, or worse, learn which mortgage tracks to avoid, thus becoming less profitable customers, God forbid).In summary Despite the opinions of various "experts" representing the contractor or the bank, the numbers show that there is no solid basis for concern regarding indexation to the construction input index. Paying in advance did not actually save us money, but it did put the money we paid upfront at risk. In my opinion, it is best to pay the contractor as late as possible.
Wow, Rimon, excellent post. As someone who has done exactly what you wrote, meaning I postponed most of the payment until the apartment move-in date, this article greatly encouraged me, given the constant fear of rising construction input prices!!!I have no doubt that you're the person I'll want to consult when I want to take out a mortgage!Thank you very much for the excellent post (by the way, all your posts are excellent). FelixReply
Felix, Thank you very much. I'm glad you acted similarly. Most people's intuition is to pay late. The problem is that when intuition clashes with salespeople, the salespeople usually "win.". They have more sales experience and are perceived as "professionals". Keep up the good work, Pomegranate.Reply
You ignored the interest rate risk. In the first alternative, a significant portion of the mortgage is taken out at the beginning for the first payment, and the interest rate is fixed. In the second alternative, do you take the loan after a year, or, as you usually write, is it about more time, and then it will be at a different interest rate? In today's environment where interest rates are very low, although no one knows if they will continue to fall, stay at this level, or rise, this is precisely the risk in a situation where there's nowhere to cover the increase from.Reply
Hello and thank you for your comment, A few things, A. The recommendation to "keep interest rates low because they are very low" has been in place for over a year. You know what has happened in the past year. The Bank of Israel's forecast for the next five years is for continued low interest rates. B. Let’s assume that interest rates will rise slightly but the loan amount will be smaller (during these years we continued to save rather than pay a mortgage); we will most likely come out ahead even if interest rates are higher. Of course, each case must be calculated based on its specific details. Interest rate fixation applies only to fixed-rate loans. Most borrowers take out approximately 30% or more of their loan at a variable interest rate (prime rate and others). In such cases, of course, "interest rate fixation" is irrelevant.General note on interest rates, Always calculate the change in interest or the difference in interest rates between different alternatives based on their impact in shekels, not in percentages. Good luck.Reply
For general knowledge, bank interest rates have already risen by half a percent since December 2014, and now by another half a percent on the fixed non-linked interest rate track. (I haven't checked the other tracks, but this should reflect them too, except for Prime). As a couple who calculated the risk between indexation and bank interest rates, we chose to pay everything upfront except for the Prime portion, which will be paid upon receiving the keys. We fixed the interest rates at one percent less than what banks are offering today. There is no winning formula; one just needs to combine the two payment methods to minimize losses, and even that isn't certain. I took on a 3.5 percent increase over eighteen months for the construction input index, and by checking a one percent increase on the mortgage, I saw a saving of 150,000 over twenty years. It's not even close to the savings if we had paid at the end, which is approximately 30,000. The conclusion is that ignoring the rise in interest rates is incorrect, even though your article contributed a lot.Reply
Hello to you and thank you for your response. Unfortunately, you’re not quite right. Let’s take a 15–20-year non-indexed fixed-rate example: in December 2014, the average interest rate was 3.59%. This month, the average is 3.08%. You can view the table of multi-year averages on the Bank of Israel website – http://www.boi.org.il/he/BankingSupervision/Data/Pages/MorgageRate.aspxIn fact, it has already been said (by a French presidential candidate) that making predictions is difficult, especially when it comes to the future. Clearly, there may be some who benefit from making early payments in certain cases. As I showed in the calculation above, the majority will not benefit from this. In any case, the impression given by contractors and the bank’s mortgage brokers—that making early payments is guaranteed to save money—is unfounded, not to mention misleading. By the way, if you’re certain interest rates will rise, then choosing the 30% Prime plan would be a big mistake for you. With this plan, you’re essentially betting against a rate hike. If I thought, like you, that it’s worth locking in a rate early, I’d recommend the 100% fixed-rate plan. Good luck and congratulations on your new home.Reply
In my opinion, I’m definitely not mistaken in my case. I went to the bank three times and received three different offers as interest rates rose over the course of six months. The first time, they offered a fixed, non-indexed rate of 2.93 percent; the second time, a fixed, non-indexed rate of 3.35 percent; and now it’s gone up by another half a percent, and this is data from the bank itself. Second, you should already know that the prime rate does indeed depend on the Bank of Israel’s interest rate, whereas the interest rates on other tracks can change even if the economy’s interest rate remains fixed or even drops. Taking a one-third prime rate doesn’t mean I’m against fixed rates; the prime rate will rise because eventually the economy’s interest rate will rise, but the repayment amount on the prime rate track is much more manageable, and of course it’s important to diversify tracks so the risk level goes down. Let’s go back now to the interest rates on other tracks—you’ve mixed a few issues here—interest rates can rise regardless of the Bank of Israel’s rate… I maintain that the interest rate on the fixed track, which is not index-linked, has risen by nearly one percent from December 2014 until now, and this is a fact!! I did the right thing with minimal risk, and I chose to pay in advance except for the prime track. And indeed, after the interest rates on the tracks (not the prime track) rose, it showed me that this was the right move. My savings aren’t from paying in advance but from locking in the interest rate!!
In my opinion, I’m definitely not mistaken in my case. I went to the bank three times and received three different offers as interest rates rose over the course of six months. The first time, they offered a fixed, non-indexed rate of 2.93 percent; the second time, a fixed, non-indexed rate of 3.35 percent; and now it’s gone up by another half a percent, and this is data from the bank itself. Second, you should already know that the prime rate does indeed depend on the Bank of Israel’s interest rate, whereas the interest rates on other tracks can change even if the economy’s interest rate remains fixed or even drops. Taking a one-third prime rate doesn’t mean I’m against fixed rates; the prime rate will rise because eventually the economy’s interest rate will rise, but the repayment amount on the prime rate track is much more manageable, and of course it’s important to diversify tracks so the risk level goes down. Let’s go back now to the interest rates on other tracks—you’ve mixed a few issues here—interest rates can rise regardless of the Bank of Israel’s rate… I maintain that the interest rate on the fixed track, which is not index-linked, has risen by nearly one percent from December 2014 until now, and this is a fact!! I did the right thing with minimal risk, and I chose to pay in advance except for the prime track. And indeed, after the interest rates on the tracks (not the prime track) rose, it showed me that this was the right move. My savings aren’t from paying in advance but from locking in the interest rate!!
One more small thing, see the attached article from the Globes website. http://www.globes.co.il/news/article.aspx?did=1000727861The article title is "Buying an apartment "on paper": Is it worth paying most of the amount in advance?". It's worth reading. They reached the opposite conclusions from you—meaning, it is worth paying in advance. But in general, it all depends on interest rates and indices, and none of us can predict that...Thanks for the interesting discussion!
Thank you for the referral to the Globes article. The author of the article overlooked one small detail—240,000 shekels, if invested wisely over three years, will generate a return. A return of 31% is not unusual, and we’ve already pocketed an additional 20,000 shekels. I'm sorry, but this inaccuracy, along with the completely false statement that bank guarantees secure my money, has taken away my desire to carefully read the rest of the article. All the best.
Dear M, if your specific case has higher statistical reliability in your opinion than The average of all loans given during this period, as indicated by the Bank of Israel in the link above, So in my opinion, we've lost the ability to have a productive discussion. I am glad you are satisfied with your choice and wish the same for all other readers. Many successes. If you're interested in reading more about the factors behind interest rate changes, you're welcome to read here: http://www.effectivemortgage.co.il/1468 With blessings and respect, Pomegranate
Hi, I have a question, I hope it's not obvious and I don't sound like an idiot... When buying an apartment from a contractor, is it better for the input index to rise or fall?Reply
Hello Miri, Pita bread is only for those who are too embarrassed to ask. The price of the apartment, or more accurately, the portion of the apartment's price that you haven't paid yet Tied to the index. This means if the index rises, your debt to the contractor rises as well. If the index goes down, it depends on the contract; some contractors peg it one-way to the index. And there are those for whom when the index falls, the debt falls. Good luck.Reply
Pomegranate hello, , Are there any caveats regarding the "Price for the Resident" program? Since projects starting now will be ready for occupancy in about two to three years, given the construction cost index and other factors, what do you suggest we do in principle? On the one hand, there is the option of postponing the mortgage application by making an initial payment to the contractor as requested, thereby delaying the mortgage application; on the other hand, there is a discrepancy between the loan terms and the mortgage terms, so this is a financial consideration that must be taken into account.Greetings,Abiran Everyone should know – the book "Efficient Mortgage" is very eye-opening, I'm waiting from page to page!Reply
Hello Aviran, First of all, thank you very much for your kind words. Second, in the "Price for the Resident" project, the contract between the contractor and the buyer is actually written by the state. Payment is always according to the progress rate, and the buyer has no freedom of choice regarding the payment date. Thanks again, PomegranateReply
Is the linkage calculated for each payment or on the entire principal? Suppose the apartment costs 100,000 NIS and the first payment is 10,000 NIS. The index has risen by 0.1 since the start of the contract. How will the linkage be calculated? On the 100,000 or on the 10,000 payment? What will the next payment be calculated on? Was there a place where it was written that VAT is paid on attachments? Is that correct?Reply
Hello Noah and thank you for the reading. I'm sorry, I didn't understand your message. PomegranateReply
For example, an apartment that costs 1 million NIS, and I pay 25% of it upon signing the contract. The occupancy is in 7 months… How does the indexation on the remaining 750,000 shekels work? How am I supposed to calculate this if it's not annual? Each month separately?Thank you.Reply
Hello Max and thank you for reading, Each month, you multiply the current debt amount by (1 + the percentage the index rose). Suppose the debt is 100 NIS and the index rose by half a percent each month. In the first month, you multiply 1000 by 1.005 and get 1005. In the second month, you multiply 1005 by 1.005 and your current debt Becomes 1010.025 and so on. Good luck.Reply