The new directive by the central bank's banking regulator will apply to loans approved from May 5, 2011. The limit applies on new variable interest rate housing loans where the interest rate is likely to change in a period of less than five years.
Israeli banks give customers the option of taking part of their mortgage at a variable rate and part at a fixed rate. About 85% of new capital lent in the past year was taken at variable rates, the central bank said.
The directive also requires banks to notify customers who have already taken out housing loans with more than a third at variable interest rates indexed to banks' prime rate, of the new measure.
The aim of this disclosure requirement is to increase the awareness of those borrowers to the possible effects of a rise in the interest rate on their monthly payments, and to help them assess this risk and the possibility of reducing it.
House prices have risen 16% in the last 12 months and the Bank of Israel has warned of a housing market bubble and has signalled it will keep raising interest rates.
"The draft directive was published in light of continued trends in the house market, primarily the significant volume of housing loans granted at variable interest rates, which incorporate an inherent risk to borrowers, and consequently to the overall banking system," the central bank said in a statement.
"The risk is entailed in the possibility that the interest rate will rise and will markedly increase borrowers' monthly mortgage payments, to an extent that will impact on their repayment ability. This scenario has become more realistic in light of the current trend of rising interest rates in the economy."
'Demand for housing won't decline'
It said many financial crises that have occurred in other countries began with housing credit granted under terms that did not reflect the risks developing in the sector, and that were inappropriate in light of the rapid rise in housing prices.
"The new directive is intended to prevent developments of this type, for the interest of the public and the whole financial system," it said.
Banking regulator David Zaken said on a conference call there has not yet been a rise in borrowers falling behind on mortgage payments "because we are in a good period. But this could change," he said.
Micahel Sarel, chief economist at Harel Finance, said demand for housing is not expected to decline substantially as a result of this measure and therefore prices will not be affected.
"This measure is not expected to cool off the real estate market and to our understanding does not aim to do so, since it does not limit the size of the mortgage borrowers can take but rather the composition," he said.
"If the Bank of Israel is concerned about housing prices, a more efficient way of cooling off demand is raising interest rates or limiting the size of the total mortgage as a percentage of the property's value."
The central bank on Sunday held its key lending rate unchanged at 3% after a half-point increase last month, but said it was considering measures to tighten mortgage credit.
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