For many people, purchasing real estate is one of the biggest financial decisions of their lifetime. It is worth knowing the most important aspects of financing.
Therefore, this article is dedicated to the most important element of financing: the mortgage.
Mortgages: what is behind the term and why is it needed?
A mortgage is a loan secured by a property. In other words, the bank grants a loan for the purchase of the property, which is then secured by a real estate lien. If the borrower defaults, the bank has the right to sell the property.
There are several reasons for financing a property with a mortgage. On the one hand, real estate and building land prices are very high at the moment. On the other hand, the interest costs for raising capital are at a historically very low level. This makes real estate a lucrative investment in the current interest rate environment, especially compared to holding cash.
Mortgages: these are the conditions and this is how the amount is broken down
In principle, two conditions must be met in order to take out a mortgage.
Loan-to-value ratio: achieving the right balance
The loan-to-value ratio describes the relationship between the mortgage and the value of the property. The rule is: at least 20 percent of the property value must be contributed as equity. Equity includes cash assets, personal loans, preferential inheritance rights as well as the advance withdrawal of funds from pillar 2 or 3. However, at least 10 percent of the property value must come from a source other than pillar 2.
If the equity amounts to less than one-third of the property value, the financing is usually split into two mortgages. 67% of the value of the real estate will be financed via the first mortgage, 13% via second mortgage.
The difference between the two mortgages is the amortization: there is an obligation to amortize the second mortgage.
Affordability: it must be possible to bear the running costs
The second requirement is the affordability of the mortgage, i.e. the ongoing costs of the mortgage (interest, amortization, maintenance) should not burden gross income by more than one third. To calculate affordability, providers use an imputed rate of interest, usually between 4.5 and 5%, which is significantly higher than the current real interest costs. On the one hand, this “safety margin” raises the hurdle for mortgage lending and, on the other hand, it ensures that the mortgage debt can be met even in the event of rising interest rates or a loss of income in the future. Moreover, the question of affordability often comes to the fore on retirement – since gross income is then usually significantly lower (see the section on Mortgage affordability in old age).
The property value as the starting point for financing
The loan-to-value ratio and the affordability depend on the value of the property. Aspects such as the location, the municipality (taxes), the plot area, equipment or even the need for renovation are decisive factors. And, of course, the question of whether you want to build or buy a house.
The easiest way to find out whether you can afford your dream property and the mortgage is to use the UBS mortgage calculator.
You have already fulfilled your dream of owning your own four walls. Are you now thinking about purchasing a vacation home? When buying a vacation home or an investment property, other requirements for financing apply. For example, in the case of a vacation home: you need at least 40 percent equity, and funds from pillar 2 or 3 cannot be used.
The question of the mortgage interest rate and the term
Once you have the necessary equity and have made sure you satisfy the conditions for affordability, the next step is to choose the right mortgage. This is because the term and mortgage interest rate model are crucial for the longer-term costs of a mortgage.
There is a whole range of different mortgage models available nowadays, each with different advantages and disadvantages depending on the situation. These two models are the most common:
- Fixed-rate mortgage: here, a fixed interest rate and a fixed term of between two and ten years are defined with the bank. If market interest rates rise, you have nothing to worry about as the borrower. However, fixed-rate mortgages are usually more expensive than money-market financing. In addition, the fixed-rate mortgage is relatively inflexible, and exit costs may be incurred if the contract is terminated early. In addition, there is theoretically a refinancing risk if a mortgage has to be renewed at a higher interest rate at the end of the fixed term.
- SARON mortgage: the SARON mortgage is a money-market mortgage that has an indefinite term and whose interest rate is based on the SARON (Swiss Average Rate Overnight), i.e. it is variable. SARON is the new reference rate in Switzerland to replace the LIBOR as the benchmark interest rate. For a SARON mortgage, the interest period is three months. The interest rate and hence the amount of interest to be paid are determined on the penultimate day of each interest period. In this way, you benefit on the one hand from the unlimited term of the contract and on the other hand from any decreases in interest rates. You can protect yourself from rising interest rates by converting your mortgage to a fixed-rate mortgage when rates rise. A money-market mortgage is currently the most cost-effective form of financing.
In addition, there are other mortgage models and combinations are also possible. The best way to find out which mortgage suits your real estate financing is to arrange a consultation.
Financial decisions need to be made even after the mortgage is taken out
Anyone who already has a mortgage knows that a mortgage entails other financial decisions.
These topics should be on your radar:
Amortization: how and when to repay
As with any debt, there is the matter of repayment. If a first and second mortgage have been taken out to finance the property, the second mortgage must be amortized within 15 years or by the age of 65. The amortization of the first mortgage depends on the agreement reached when you sign the contract.
When it comes to amortization, direct repayment is usually the standard option. You can still choose to pay off the debt indirectly from private retirement savings. These are the advantages and disadvantages of direct and indirect amortization:
- Direct amortization: you make regular repayments – usually quarterly – of a fixed amount of the debt. This way, your debt decreases, and so does the amount of mortgage interest owed. But since you can deduct this from your taxes, your tax burden increases. It is advisable to budget the direct amortization carefully and to consider how the repayments will affect other budget items such as pensions or maintenance.
- Indirect amortization: in addition to direct repayment, you can also repay your debt indirectly. To do this, you transfer an amortization amount to pillar 3a, which is pledged to the bank as collateral. This means that your debts remain unchanged. On retirement, the capital paid in in this way then goes directly toward the amortization of the mortgage. In this model, the interest burden is not reduced, but the tax burden does not increase either. In addition, you benefit from a tax exemption on the 3a funds. In the case of indirect amortization, the maximum possible amount per year is the pillar 3a maximum amount (2021: 6,883 francs).
As you can see, the question of amortization depends on the interest rate environment and the tax situation. Repayment reduces the debt and the interest, but you pay more taxes. Another factor to consider is that the capital will be unavailable to you for other profitable investments. You can also read more about amortization here.
Mortgage affordability in old age
Another question that often arises is what needs to be considered after retirement when it comes to mortgages. For example, if you are due to retire in the next 15 years, a shorter amortization period may be required. And even once you have retired, housing costs should not exceed 33 percent of income. Since the second mortgage is amortized on retirement, the interest burden is also lower. But income is also generally lower in retirement.
After the age of 50, it may also be worthwhile to adjust your mortgage strategy. The best way to do this is to talk to an advisor.
Extending, increasing and adjusting a mortgage
Do you want to renovate your house? Or maybe your circumstances haven’t changed at all, but the term of your mortgage is coming to an end. You basically have three options for your mortgage:
- Extending: you can extend your mortgage if your circumstances have not changed much, for instance.
- Increasing: if, on the other hand, you want to finance a renovation or a conversion, you can increase your mortgage. However, the same conditions apply in terms of loan-to-value ratio and affordability as at the beginning of the term.
- Adjusting: to adapt to new living circumstances, for example due to professional or family changes such as a divorce, it may be worth reassessing your mortgage strategy.
Talk about long-term financial decisions
Buying and financing a property is neither an easy nor a minor financial decision. It’s also rarely a decision you make alone. Discuss the subject with your partner, family and friends – decisions that are made jointly provide more security.
It is also worth seeking advice from an expert when making such decisions. We will be happy to help if you have any questions.
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