Financing your home Mortgage amortization: when does it make sense?
Debts need to be repaid. But amortizing a mortgage in full is seldom the best solution. We explain what you need to know.
The most important information at a glance
The most important information at a glance
- When talking about mortgages, amortization means the repayment of a mortgage loan.
- A maximum of two-thirds of the market value of your home is financed by the first mortgage, which you don’t necessarily have to repay.
- You must amortize the second mortgage within 15 years.
- With direct amortization, the debt is reduced by a fixed amount at regular intervals.
- With indirect amortization, the amounts used to settle the debt are paid into a retirement solution such as pillar 3a.
What does amortization actually mean? Amortization is the technical term for paying down a loan, such as a mortgage on a property. Second mortgages are usually amortized in regular tranches. If the first mortgage is fixed-rate, it can be renewed at the end of its term or amortized all at once.
The first mortgage does not need to be amortized
The first mortgage does not need to be amortized
In principle, up to 80% of the market value of a property, as determined by the bank, can be financed with mortgages. A maximum of two thirds of the value can be financed via the first mortgage. The law does not require it to be amortized; in principle, you can maintain it for as long as you want. A second mortgage finances the remaining share. This second mortgage must be repaid within a maximum of 15 years.
Direct mortgage amortization
Direct mortgage amortization
A mortgage can be amortized either directly or indirectly. Direct amortization means the debt is reduced by a fixed amount at regular intervals, generally once a quarter. This reduces the debt amount and therefore also the interest burden. However, only a lower amount can be entered under the deductions on the tax return, leading to higher taxes.
Calculating direct amortization
Calculating direct amortization
The tranche for amortizing a mortgage is easy to calculate: simply divide the mortgage amount by 15 years to get the annual tranche. And if amortization is quarterly, divide the annual tranche by four. Specifically: If the second mortgage is CHF 150,000 and the mortgage runs for 15 years, the repayment will be CHF 10,000 per year or CHF 2,500 per quarter.
Indirect amortization with pillar 3
Indirect amortization with pillar 3
In the case of indirect amortization, equal amounts are repaid every quarter or year, but the tranches are paid into a pension solution that you have pledged to the bank as security, rather than to the bank. Indirect amortization is usually via pillar 3a. Indirect amortization allows you to build retirement savings and also saves on taxes, because pension contributions are tax-deductible. The capital is paid out when you retire. The retirement savings are then used to reduce the mortgage, if necessary.
Direct and indirect amortization in comparison
Direct and indirect amortization in comparison
Indirect amortization is generally more advantageous than direct amortization. Whether this is true for you depends on the interest rates and on your personal tax situation. The calculation below illustrates the difference between direct and indirect amortization. It is based on a second mortgage of CHF 200,000 to be amortized within 15 years. Further assumptions: Mortgage interest rate 3%, pillar 3a interest rate 0.05 % (same as Fisca account), marginal tax rate 33% (= tax rate applied to the next income unit – not including wealth tax), amortization payments or pillar 3a contributions made at the end of the year, 6% capital tax on 3a withdrawal.
Expense | Expense | Direct amortization | Direct amortization | Indirect amortization | Indirect amortization |
|---|---|---|---|---|---|
Expense | Amortized amount | Direct amortization | 200 000 | Indirect amortization | 200 000 |
Expense | Mortgage interest | Direct amortization | 48 000 | Indirect amortization | 96 000 |
Expense | Tax savings through deduction of debit interest | Direct amortization | –15 900 | Indirect amortization | –31 700 |
Expense | Interest on pillar 3a balance | Direct amortization |
| Indirect amortization | –700 |
Expense | Tax savings through deduction of pillar 3a contributions | Direct amortization |
| Indirect amortization | –66 000 |
Expense | Tax on pillar 3a capital withdrawal | Direct amortization |
| Indirect amortization | 12 000 |
Expense | Total costs | Direct amortization | 232 100 | Indirect amortization | 209 600 |
Expense | Benefit of indirect amortization | Direct amortization |
| Indirect amortization | 22 500 |
Pros and cons: amortization of the first mortgage
Pros and cons: amortization of the first mortgage
Amortizing your first mortgage reduces both the debt and the interest burden, just as it does with your second mortgage. Repayments can be agreed when the first mortgage is taken out. Without such an agreement, with fixed-rate mortgages the term should always be considered because an early redemption penalty will apply if a mortgage is repaid early. At the end of the term you can either: repay the debt in full or in part, extend it or renew it. With UBS variable interest rate SARON mortgages, amortization is possible every month (UBS SARON Flex) or every 13 months (UBS SARON).
As well as the advantages listed above, amortizing the first mortgage also has disadvantages. For example, you can no longer claim tax relief on the mortgage interest, the money is no longer available to invest, to save towards your retirement, to spend on renovation work or to cover nursing costs in old age. In addition, the decision to amortize can often not be reversed after retirement, as the options for increasing your mortgage can be limited due to lower income. You will need to check carefully whether amortizing the first mortgage at the end of its term is worthwhile for you by answering the following questions:
- How high will the interest burden be if you renew the mortgage?
- What tax increase would result from an amortization due to the lower deductions? Take into account your tax domicile and individual wealth and income situation.
- Will your existing investments be reduced by the amortization, thus lowering the returns on these investments?
- Do you have cash reserves that can be used for the amortization?
- After amortization, would you still have sufficient reserves for any renovations or for unplanned expenses, for example, for the costs of nursing or to replace your car?
- How has the value of your property changed?
No general recommendation can be made regarding voluntary amortization. You will need to answer the questions for yourself and weigh up the individual factors. Your answers will also be a good basis for a consultation with an expert. Homeowners often consider amortization as they approach retirement, as this has a major impact on their income. Ideally you should discuss amortization with your bank 10 to 15 years before you retire as part of a comprehensive pension plan consultation.
