Swiss mortgages – the good, the bad, and the ugly
Let’s be honest: Swiss mortgages are weird. I can’t say that they are unique in the world in terms of structure but they’re at least unusual. Some features are great but some are just ugly. In this article, we’ll explore all the facets of Swiss mortgages. This discussion applies especially for home ownership and while so aspects transfer to mortgages for real estate investment, not all of them are applicable.
Swiss mortgages: the good
You may use retirement money for the deposit
Banks will accept up to half of the deposit from your second pillar (that’s the retirement fund you and your employer are required to contribute to). The other half has to be in cash or from your third pillar (the retirement fund only you may contribute to). That eases the burden slightly. It is also possible to pledge those retirement accounts, which can have some advantages (which we won’t discuss today).
Amortisation is optional
The best feature of Swiss mortgages is that the bank will only require you to pay back the mortgage until you’ve reached 35% equity. In other words: if your house is worth 1 million francs, you need to pay the mortgage back until you owe the bank 650k. At that point, you may continue to pay it back. But you’re not required to do so. The bank will be perfectly happy to let you pay only the interest until the maturity of the mortgage. This is great because it considerably reduces your monthly payments once you’ve reached 35% equity, especially considering today’s interest rates. To put it into numbers: if your mortgage is at 1%, a 650k mortgage will cost you 6,500 francs per year, or 542 francs per month. That’s lower than the rent of my room in Zürich when I was a student!
You can roll the mortgage at maturity
Mortgages have a maturity date. For instance, 10 years from the date you bought the property. At the end of those 10 years, you’re supposed to pay back the mortgage in full. That’s quite difficult to do. But there is another option: you may contract another mortgage (it can be from the same bank) to pay back the first one and continue for another 10 years. In practice, you’re afforded the same luxury as states. States never pay back their debts. I mean, they do, but they use new debt to pay back old debt.
Some people find this feature to be a drawback. And to those, I say: you don’t HAVE to roll the debt, you can also pay it back, it’s completely up to you.
Now, let me explain why rolling (low interest) debt is awesome: Let’s say that at age 35, you owe 650k borrowed at 1%. If you earn 65k per year, that’s 10 years of wages to pay it back. That’s quite the effort. Now, let’s imagine that inflation is at 1% per year and that your salary only increases by inflation plus an additional 1.5%. 30 years later, right before retirement, you now earn around 136k per year. But you still owe 650k. Now, instead of 10 years of earnings, you only owe 5 years of earnings. Your debt has effectively shrunk.
*Commercial voice* But wait, there’s more!
Let’s compare two individuals both owing 650k on an interest-only mortgage at 1%. One choose the pay it back in 20 years (Alfred), the other chooses to only pay the interests (Benny).
My calculator says that Alfred needs to make monthly payments of around 3,000 francs in order to owe 0 after 20 years. Benny, on the other hand, only makes monthly payments of 542 francs (let’s round it up to 550). So, Benny has, every month, 2,450 francs « in excess » compared to Alfred. Let’s say that he chooses to invest that money into an investment vehicle yielding 5% per year.
After 20 years, Alfred has no debts. Good for him. He may now live rent free in his house. Good for him. Benny, on the other hand, still owes 650k to the bank. BUT, he has accumulated a grand total of 1 million francs through his regular investment. So at that point, he could choose to pay the 650k back and he will still be left with 350k more than our friend Alfred. Or he could roll the debt, keep making the interest payment, and 10 years later, he’ll still owe 650k while having accumulated an additional million francs.
There is a valid objection to this: getting 5% rarely comes without risks. That’s true. So, what would be the minimum interest rate Benny would need to make even with Alfred. In other words: what kind of yield does Benny need to have 650k after 20 years. Well, you might have already guessed it: around 1%. That sounds achievable.
Swiss mortgages: the bad
The interest rate is only fixed until the maturity date
In the previous section, we imagined that the mortgage could be rolled at the same low interest as the original mortgage. But those rates are an exception in History. Maybe they won’t stay that low. Maybe, 10 years from now, interest rates will be around 3% – not crazy high by historical standards. But that’s 3 times higher than today, which means 3 times higher monthly payments. Imagine being used to a life of leisure, paying 542 francs per month in « rent » to the bank and suddenly, you have to pay 3 times that amount. This will require some lifestyle changes. The best way to mitigate that is to adopt the strategy of our friend Benny: calculate how much it would cost to amortise the mortgage in 20 years and invest the difference to have some capital at the maturity of the mortgage to pay back at least part of it if interest rates are crazy at that time.
Banks are set on the 20% deposit
To contract a mortgage on a property in Switzerland, you need a 20% deposit. There is no way around that. That’s A LOT of money. Going back to our example above: a 1 million property requires a 200k deposit. How long does it take to save that kind of money while still paying rent? Quite some time. And worse: once that money has been used to pay the deposit, it stops being invested wherever it was invested before (unless it is pledged). The opportunity cost (the money that you don’t earn because the capital isn’t invested) are large.
It cost money to pay back early
Imagine that 3 years into a 10 years mortgage, you decide to sell your house to buy a new one. In effect, you need to pay back your current mortgage with the proceeds of the sale and contract a new mortgage for the new property. One caveat though: the bank will still charge you the interests payments of 7 missing years as a fee. How is that fair? It’s not, but the bank has the money so they can do whatever they want.
Another case where this feature might hurt: imagine that you borrow at 1% and 3 years later, you realise that it’s possible to borrow at 0.5%. Can you change bank to cut your interest payments in half? Yes, but the fee makes it a bad financial decision.
Bank won’t give you a mortgage even if you can easily afford the payments
Before giving you a mortgage, the bank will perform what is called in German a Tragbarkeitsrechnung or a calcul de soutenabilité in French (I really can’t find a good translation in English, I’m sorry). This is a calculation aimed at making sure that you earn enough to face the monthly payments. In a nutshell, they will take the value of the mortgage, assume a 5% interest rate, a 1% cost of maintenance of the property, and a 1% yearly amortisation. That amount can’t be higher than 33% of your income. That means that, to buy the now famous 1 million francs property with a 20% deposit, you need to earn at least 180k per year (!!). But the monthly payment are only 1,667 (interest plus amortisation), which virtually everyone already pays in rent.
Swiss mortgages: the ugly
Those ugly features are, for me personally, the reason I don’t think I will ever contract a Swiss mortgage despite the sweet sweet benefits of optional amortisation and rolling of the debt.
Sometimes, even fixed interest aren’t fixed
This is nasty. The advantage of choosing a fixed mortgage is planning security. You know that whatever happens, you will only have to pay X francs per month in house payments. Some banks found that providing essentially free money (anything below 1% is essentially free, given that there is a little bit of inflation) was too risky. So they added a small font clause which lets them raise the rate if certain events were to take place. I want to stress that no all banks have this clause in place.
Expect a call if the value of the property changes
An important element of any loan is the collateral. The collateral is the guarantee the lender has in case the borrower stops making payments. In the case of a mortgage, the collateral is the property itself. If the borrower stops making payments, the bank will foreclose the house (seize it and sell it). In theory, the value of the collateral should be around the same at the loan but the bank would like some extra safety; that’s why they will only lend you 80% of the value of the house, and yet, they can seize the whole house if you default. That way, they make sure that even if they get a terrible price for the property, it will most likely cover their losses.
Now, imagine that, 10 days after buying the house with a 20% cash deposit, there is a spillage in a chemical plant nearby. Suddenly the value of the house decreases by 20%. The house was worth 1 million, now it’s worth 800k. So, not only have you lost all of your 200k investment (yes, 100% of it), but what’s worse is that the value of the collateral is now the same as the value of the house. That’s not OK with the bank, because they need an extra layer of safety. So you will get a phone call asking you to come up with 20% of the new value of the house within a few weeks. That’s 160k. If you don’t have 160k, the bank will foreclose your house. Let that sink in.
The worse part of this is: it is explicitly stated that if the value of the property decrease, according to the estimates of the bank, they will require additional payments. They are at liberty to decide if your house is now worth less. They can arbitrarily decide that you have to give them large sums of money.
A new Tragbarkeitsrechnung is possible at anytime
Imagine that when you buy the 1 million house, you and your spouse do earn a combined 180k. You fulfilled the crazy standards of Swiss banks, congratulations. Now imagine that a few year down the line, you decide to have kids and to work part time. No worries, anyone can afford 1,667 monthly payments on a 120k salary. But, let’s say that the bank caught on that. They are allowed to conduct a new Tragbarkeitsrechnung with the same insane conditions. And if you don’t fulfil the standards, they can call back the loan! So, you’re essentially obligated to keep earning as much for the entirety of the duration of the mortgage! I don’t want to use the word slave but I really really want to.
Any banker or mortgage consultant will tell you that never, oh never will a bank use those contract clauses to call back a loan. To which I always answer: « then you’ll have no issue if we remove them from the contract ». Then they smile and say that, unfortunately, it’s company policy, etc.
Right now, there are billions of francs of mortgage loans at 1%. Now, imagine that in 5 years, interest rates go to 3%. The temptation for banks to propose the following bargain will be huge: Either we call back the loan using one of those clauses. Or you agree to a new mortgage at 3%. That’s bad for their image but really good for their balance sheet.
That was the good, the bad, and the ugly of Swiss mortgages. Thanks for reading!
If there are other features (good, bad, or ugly) of Swiss mortgages that I didn’t discuss, feel free to mention them in the comments below. If you would like to read about my crazy strategy to never pay back your mortgage, here it is.