The Complete Guide to Mortgages in Switzerland

Mortgages in Switzerland

Mortgages in Switzerland are quite complicated. While the basic idea is straightforward, there are many refined principles about them.

If you are planning to buy a house, it is essential to know as much as you can about mortgages. You do not want to get a bad deal from your bank because you did not fully understand what something meant.

The most distinctive nature of Swiss Mortgages is that they are generally not repaid! In most countries, people are fighting to repay their mortgages entirely. But in Switzerland, most people will not reimburse more than 35% of the house value. And they will keep a mortgage for life.

The reason is the strong relationship between mortgages and taxes. It is essential to know this before you ever think of taking a real estate loan.

How much can you afford?

An important topic is to understand how banks are computing how much they can lend to you.

There are some strict rules based on your income level. Generally speaking, with a higher income, you can pretend to a higher mortgage.

Now given the current record-low rates, you could think that you can afford a mortgage on two or three million houses. And in practice, this is probably true. But the affordability computation is done using theoretical rates. The idea is that the bank does not want to lend you money if you cannot afford a hike in rates.

So, banks are currently using a 4.5% theoretical interest rate as a reference. Some are even using a 5% rate. On top of that, they are accounting for 1% amortization per year. And depending on the bank, they will account for between 0.5% and 1% in maintenance costs.

For instance, our bank, Migros Bank, used a total of 6.2% as the rate for computing the costs.

I do not understand why these rates are so high currently. The interest rates in Switzerland have never stopped falling in the last ten years. But this is not something we can do anything about. This high theoretical rates will highly limit your capacity to get a loan.

Once they have calculated the total costs of your house, this total must be lower than 33% of your income. So, in our case, 6.2% of the mortgage needs to be smaller than 33% of our income. You need to take 6.2% of the value of the loan into account, not of the value of the house. In general, the mortgage will be 80% of the house value.

Depending on the bank, how they compute your income is a bit different. But in most cases, they will consider your previous year’s taxable income. And there are some exceptions. For instance, in my case, they refused to take my bonus into account because I could not show up three years of bonus payment. If we had waited one more year, we could have afforded a significantly more expensive house.

Based on that, you can easily compute how much you can afford: House =(Net Income / 3) * (1/0.062) * (1/0.8). If your bank uses another theoretical rate, you can just change the 0.062 by the other rate. For instance, an income of 100’000 gives a maximum value of 672’043 CHF. It should give you a rough idea of how much you can afford.

It does not mean that you cannot afford more. If you want to borrow more than that, you will have to increase the amount of downpayment you are putting down. By doing so, you will reduce the amount of mortgage and reduce the theoretical costs. But there is not much advantage in doing so.

If you want to get a higher mortgage, your best solution is to increase your income.

Downpayment

The bank will not provide the entire value of the house as a mortgage. You will have to pay a part of the value of the house in advance. This advance payment is called a downpayment.

The reason for a down payment is to force people to save for a house. Authorities do not want to make it too easy for people to get a house if they are not able to save money.

In general, you must pay 20% of the value of the house in advance. So, your mortgage will be 80% of the value of the house. You could have a larger downpayment. But as we will see later, it is not always beneficial to do so in Switzerland.

At least half of the downpayment must be in cash. And the rest can come from your retirement money. To be precise, you can withdraw from your second pillar and your third pillar.

If you are younger than 50, you can withdraw your entire second pillar. If not, you can withdraw the amount of money that you had in your second pillar when you were 50 (or half of your second pillar when you withdraw, whichever number is higher).

Of course, you need to take into account that this will reduce your retirement income. Also, regarding the second pillar, you will not be able to deduct voluntary contributions from your taxable income. You will first have to repay your withdrawal. And the voluntary contributions you did in the last three years cannot be withdrawn for a real estate property.

If you do not have 10% of the house in cash, there are still a few solutions. However, if you are not able to get this cash, you may want to wait or not buy a property. Otherwise, You could withdraw money from your family (never a great idea). Or you could even take another loan to get the cash. This last solution is quite risky and will increase your interest.

I would recommend you make a plan to save enough cash for the house. 10% of the value of the property is not that much if you can save enough of your income. And if you do not know where to start, I have a few tips to save money in Switzerland.

Other fees

The downpayment will not be the only thing you will have to pay in cash.

When you buy a house, you will have to pay several fees:

• Notary Fees
• Property Transfer Fees
• Real Estate Acquisition Taxes
• etc.

Overall, you can expect to pay about 5% of the house value in extra fees. It is very important to consider these fees since you will need to pay them in cash. In some cases, some banks may accept to take this into the mortgage, but it is rare.

So, before you plan to buy a real estate property, you should be ready to pay 25% of the house value yourself. And 15% should be in cash, not in retirement assets.

Amortization

When you take a mortgage, you will have to repay 15% of the mortgage during the first 15 years.

So, every year, you will pay 1% of the value of the mortgage (not the value of the house). This money will get removed from the loan. As such, the interest you pay every year will decrease overtime for the first 15 years.

If you paid more than 20% as a downpayment, you will have less to amortize. You need your loan to be only 65% of the value of the house in the first 15 years.

While amortization should be simple, there are two amortization methods in Switzerland.

Direct Amortization

When you amortize your mortgage directly, you simply give money to your bank to reduce your debt.

Direct amortization is very simple. All the money you use will reduce your debt accordingly. And the interests you have to pay will be reduced as well.

Direct amortization is the standard amortization method that is used in most countries.

Indirect Amortization

The second option is to amortize indirectly through a third pillar.

Instead of giving money to your bank, you invest money into their third pillars. If you fail to pay your interests, the bank has then a right to this third pillar funds. And when you reach retirement age, the bank will use the money to amortize the mortgage.

Indirect amortization can also be done with a third pillar in life insurance. You can keep your current insurance policy and invest in it instead of amortizing the debt. And then, the bank will have a right on the insurance money if necessary.

When you amortize indirectly, your debt is not reduced. So, you will continue to pay the same amount of interest every year.

Indirect vs Direct

With direct amortization, your debt will be reduced, and you will pay less interest each year. It is not the case with indirect amortization.

So, why does that option exists? It exists for taxes. You can deduce your interests from your income. So, if you reduce these payments, your taxes will be increased. Also, the money in your third pillar is not counted towards your wealth tax.

So, it is more tax-efficient to delay the actual amortization.

Now, there is a disadvantage to indirect amortization that many people do not consider. The bank will not let you invest in the third pillar of your choice. They will force you to invest in their third pillars. And in some cases, they will force you to invest in cash-only third pillars. If you have access to cash-only third pillar, you may lose a lot of returns. But if you have to medium-stocks third pillars with this bank (or better), the tax optimization part should compensate.

In general, banks will also let you do a mix of direct and indirect amortization. So you have some margin of freedom with this.

So, you could lose a lot on your returns on this money by doing indirect amortization. So, it is essential to consider the pros and cons of both methods before choosing. And make sure to discuss also their third pillar options when you are doing that.

Kinds of mortgages

There are several kinds of mortgages in Switzerland.

The first kind of mortgage is the fixed-rate mortgage. This kind is the simplest. You fix the interest rate for a specific number of years. For instance, you could get a 1.2% fixed-rate mortgage for 20 years. It means that during these 20 years, you will pay 1.2% interest on your debt every year.

The second kind of mortgage is the LIBOR mortgage. This kind of mortgage follows the LIBOR reference interest rate. It has a short duration (one to five years) and a frequency of change (from one month to 12 months). If you have a frequency of one month, your interest rate will be adapted to the LIBOR rate every month.

The third kind of mortgage is the variable mortgage. Compared to the other kinds of loans, it has no duration. And the interest rate is also variable. However, the rates are significantly higher on this kind of loan. Since the rates have become lower these last years, this kind of mortgage has been less and popular. It makes little sense to use this kind of mortgage these days.

Which mortgage you should choose depends on your capacity to handle changes in rates. If you have a strong ability to handle risk, you should take a short-term mortgage or a LIBOR one. If you do not have a large capacity to changes in interest rates, you should try to use a longer-term mortgage.

You should also know that you can combine several kinds of mortgages. You could get a 5-year mortgage combined with a 10-year mortgage. If you do so, you should ensure that your loans will get renewed at the same time.

For instance, you do not want to take a 4-year loan with a 7-year loan. You will never be able to change banks or cancel your contracts. A 2-year with a 4-year should be fine as well as a 5-year with a 10-year. But avoid a 3-year with a 5-year.

You need to be sure not to be locked with the same bank for too long.

LIBOR and SARON

The LIBOR (London Interbank Offered Rate) comes from the financial regulatory body from the United Kingdom. However, they have decided to stop this rate by the end of 2021.

So, some banks already stopped offering LIBOR mortgages. And many people wonder what will happen to their existing mortgages. 

Banks have decided to replace LIBOR by the SARON (Swiss Average Rate Overnight). The SARON is a daily interest rate developed by SIX and the Swiss National Bank (SNB). 

We do not yet know all the details of the change to the SARON. But most banks expect that this will work mostly in the same way as a LIBOR loan. Also, since this is a Swiss interest rate, many people expect a higher level of transparency compared to the LIBOR. But we will have to wait and see.

Banks vs Insurances

Something surprising is that banks are not the only ones to offer mortgages. Large insurance companies in Switzerland are also offering them.

There are some differences in what they can offer you. For instance, insurance will generally only offer fixed-term mortgages. But they have some interesting offers with really long-term contracts.

Another big difference is that most insurers will not accept your retirement funds as a downpayment. It means that you will need 20% in cash. It is a blocker for many people.

If you have enough cash (or if you do not want to use your retirement funds), you may consider offers from insurers as well as from banks.

Withdraw or Pledge your retirement money

There is one extra special thing about using your retirement money for your mortgage. You have two choices, either you withdraw the money or you pledge it.

If you withdraw the money, it will be effectively removed from your second (or third) pillar. And it will use as payment to the seller. Doing so will effectively reduce the debt you take since you already paid it.

If you pledge the money, it will not be taken out of the account. This money will act as a guarantee for the bank. In that case, it will increase the debt you have. If you pledge 10% of the value of the house from your retirement, you will have 90% in debt. It means that you will pay more in interest, and you will have more to amortize.

On paper, it seems like withdrawing has more advantages. But there are a few specific advantages to pledging your retirement funds:

• You will keep your retirement income.
• You will still be able to make tax-advantaged voluntary contributions to the second pillar.
• You will pay fewer taxes since your interests are higher.
• You will not pay taxes on the withdrawn amount (but you will pay taxes later on anyway).

Which one you choose will highly depend on your financial situation:

• Can you afford to pay more every month?
• What is your marginal tax rate?
• What kind of returns does your second pillar generate?
• Do you want to make voluntary contributions to your second pillar?
• Are you close to retirement?

I do not think there is a huge difference between the two models. If you are getting close to retirement, it may become important. But if you are young and your second pillar is bad (like most people), I think it is better to use it. That way, you will save more money every month, and you will be able to invest it at higher returns than on your second pillar.

Should you repay your mortgage?

In Switzerland, we have a system that puzzles many foreigners. Indeed, most people never repay their debts! You can keep 65% of the debt on your house forever!

In most countries, people will tell you to repay your entire debt. But in Switzerland, this is not efficient. Indeed, this will increase your taxes. And since interest rates are currently very low, there is not much value in reducing it. The value is better invested in stocks than in a mortgage.

Also, when you reduce your mortgage, you are in0creasing your net worth. So, you will also pay more taxes on your wealth.

So, in Switzerland, you should probably not repay your mortgage. There may be some cases where it makes sense to do so. But these are exceptions rather than the rule.

Renew your mortgage

Except for variable mortgage, all kinds of mortgages have a duration.

At the end of the duration, you will have to renew the mortgage. It means you will have to choose once again a mortgage. If you are lucky, interest rates may have gone down. So you will be able to renew your debt a lower interest rate. If you are not fortunate, you will have to pay more.

You should choose again according to your financial capacity. If your situation changed, you might want a different contract than before.

When you renew a mortgage, you also have the chance to change banks. If you are not satisfied with the offer from your bank, you may want to change to a new bank. You could use offers from other banks as leverage to get a better offer from your current bank as well.

There is something fundamental about renewals. When you renew your contract, the bank will take a look at your financial situation again. They use almost the same calculations as to when you buy the property. If you cannot afford a new mortgage, the bank may force you to sell.

If you are in small financial trouble, they may be understanding. But you have to be careful about that. You can use longer durations if you expect your income to fall in the future.

Sell your property

You need to be careful with your mortgage when you sell the property.

There are two different situations. It will depend on whether you buy a new property or not.

If you buy a new property, your bank will generally let you transfer the actual mortgage to the new house. Based on the value of the new house, you may have to add some cash again to the deal. But in general, this can be done during the duration of the mortgage. You do not have to wait until the renewal of the contract. Of course, this will depend on the bank.

If you do not buy a new property, you will need to cancel your contract. It may be more complicated than you think. If you cancel a mortgage before the end of the duration, you will have to pay penalties. These penalties can be quite significant based on bank conditions. It could easily reach 50’000 CHF. So, you need to be careful about the terms of the contracts if you plan to sell your property.

Mortgages and retirement

If you buy a house close to retirement, you need to be sure you will be able to keep your property once you are in retirement.

As mentioned before, when you renew your mortgage, the bank will check again if your financial situation is good enough for this debt. And if it is not, it may force you to sell your property. And it can happen even though you are retired.

When you are retired, your income may be significantly lower than before. So, it may be difficult for your income to pass the test for the debt at the theoretical rates.

If your income in retirement is enough, you will have no issue. But if it is not, you have several solutions.

The first thing you can do is to amortize your debt. While this may not make sense from a tax point of view, it could be a great way to reduce your debt to be able to keep your house in retirement.

Another way is to rely on your kids if you have any. You could sell the house to your kids before retirement and rent it from them. Or you could ask them to guarantee the house. It means that if you could not pay the debt anymore, your children would be responsible for it. It is not a great situation. But depending on your financial situation, it could be working well.

Now, it is better to avoid this kind of situation. For this, you need to plan your retirement. You need to make sure you will have enough income in retirement so that you can keep your mortgage.

How to find the best mortgage?

Almost every bank offers mortgages in Switzerland. So, it is not easy to find the best mortgages for your property.

First of all, you should always compare several offers. If you are with a bank that offers real estate loans, you should ask them for an offer. However, you should not simply accept the first offer you get.

If you can, you should also try to get some offers from insurance companies. The more offers you get, the better chance you have at getting the best offer for your situation.

There are a few comparators online for mortgages. But I only found one helpful comparator. The mortgage comparator from moneyland is good. However, since not all banks are there, you should still contact a few banks yourself.

Conclusion

This guide covers all there is to know about mortgages. If you already know all of this, you will be well ahead of most people.

It is essential to learn about mortgages if you plan to buy a property. You may be lucky and deal with a very honest banker. But there are many stories of people getting a bad deal from their bankers because they did not know enough before starting to discuss.

So, before you start looking for a real estate property, you will need to study mortgages. And once you know enough, you will be able to talk with a banker. You need to have all the cards in your hands before that.

I have not covered how to buy a house in this article. But I will cover this in a further article. I did not want to mix purchasing a house with getting a mortgage. These are two complex subjects that each deserves its own article.

If you are still undecided, I have a guide on whether you should buy or rent in Switzerland.

Do you any more tips on mortgages in Switzerland? Did I forget anything?