How to never pay back any of your Swiss mortgage

The accepted wisdom regarding mortgages and debt in general is: pay it back as soon as possible, because the longer it takes to pay it back, the higher the interest payments will be.

And this is definitely true if you’re borrowing at 10%. Just to put things in perspective, taking 10 years to pay back debt at 10% will cost you 58% of the original amount. So if you’re borrowing 1,000, you’re paying back 1,580. Borrow 1,000 for 20 years at 10% and you’ll have to pay 2,310 back. That is expensive.

That’s why credit card debt is so dangerous: the rates are monstrous and you can usually stretch the payments over a long time.

But what about mortgages? A typical fix term mortgage today in Switzerland is around 1%. And given that you own at least 35% equity, which means that the mortgage is less than 65% of the value of the house, you don’t have to pay the debt back: you may just make interest payments. For more details about how Swiss mortgages work, see this epic guide.

A little recap on swiss mortgages

As discussed in the article the Good, the Bad, and the ugly of Swiss mortgages, with such low rates, it’s might be clever to never pay the debt back:

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.

The opportunity cost of paying the debt back is also very high: because you’re making high mortgage payments, you’re not able to invest that money at a much higher interest rate.

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.

OK, by now, I should have you convinced that paying back a low-interest mortgage is not the best use of your money.
But that’s only possible if you already own 35% equity. You still have to put 20% down when you buy and then amortise (pay back) the mortgage until you reach those 35%, usually over 15 years. Is there a way around putting that much money down? Yes, there is 🙂 But it’s a bit advanced. It’s not the typical beginner’s montage.

The first 20% – a story of buckets

For what comes next, I’m going to assume that you have a decent 2nd pillar, a decent 3rd pillar, and a margin account with your broker.

The initial 20% are actually subdivided in two buckets: the hard money bucket and the soft money bucket.

The soft money bucket can be filled with your 2nd pillar. The hard money bucket, with anything else. The soft money bucket can be, at most, half of the initial 20%. That means that, even if you have 1 million on your second pillar account, you can’t use it all to finance your property. The amount in the soft money bucket has to be matched by an equivalent amount in the hard money bucket.

Now, how to not put that money down? Well… you have the option to pledge your 2nd and 3rd pillars instead of cashing them out. Pledging means that you offer the account as a guarantee to the bank. If you fail to make payments, they can seize it. Pledging has interesting consequences: first, you’re saving on taxes, because you’re not actually withdrawing the money. Second, if the accounts are connected to a life or disability insurance, you don’t lose those benefits.

Alright, but what if that’s not enough to cover the 20%? Well… you also have the option to pledge your investment account to the bank, but I wouldn’t do that. Instead, I would take a Lombard loan with my broker. A Lombard loan is essentially borrowing against a portfolio. They lend money and use the stocks as a guaranty. Rates for Lombard loans vary but can be as low as 1.25%.

So let’s make this concrete: imagine a 1 million property, just because I like round numbers.

Our friends Alfred and Benny each have 100k on his 2nd pillar, 50k on his 3rd pillar, and a 200k stock portfolio.

Alfred chooses the classic way forward is: he withdraws his 2nd and 3rd pillar, and pays the around 5% withdrawal tax. Then he sells 50k worth of stocks. That way, he can put 200k down and the bank is happy to provide a 800k mortgage at 1%. Alfred, on the other hand, has to pay 7k in taxes from his salary and only has a 150k portfolio going forward.

Benny chooses the less classic way forward is: he withdraws his 2nd pillar, because it doesn’t earn that much with your pension fund so it’s wise to take it out. He pledges his third pillar invested in stocks and takes a Lombard loan at 1.5% for the remaining 50k. Benny gets a 900k mortgage from the bank at 1% and has a 2% loan from his broker for 50k. That might seem like a lot of debt (and it is) but, he still owns 200k in stocks earning 7% per year on average AND 50k in his third pillar, also earning similar returns. In addition, he only owes 5k in taxes.

The next 15% – rob Peter to pay Paul

Banks want you to bring your equity from 20 to 35% within 15 years. Essentially that means paying 1% of the value of the property back per year.

So that’s what Alfred does: every year, he pays 1% interest on the 800k loan, that’s 8k. Plus an additional 10k (1% of the million francs property) to amortise the loan. For grand total of 18k per year.
After 15 years, with no extra contribution, his stock portfolio has grown to 414k.

Benny, on the other hand, has to pay 1% interest on the 900k loan, that’s 9k. Plus 2% interest on the 50k Lombard loan, that’s 1k. Plus 17k to amortise the mortgage. Why 17 and not 10? Because he has to bring his equity to 35% within 15 years and he is starting from 10%, not 20. So 25% of 1 million over 15 years, that’s 17k per year. Grand total: 27k per year.

OK, that sounds terrible. Not only does Benny make higher interest payments, but he also makes higher amortisation payments. Isn’t that what he wants to avoid?

On face value, yes, it looks like Alfred is much better off. But I haven’t told you how Benny is making the payments. And here comes the trick: Benny is not paying back the mortgage with his own money: he is paying it back by increasing his Lombard loan. Wait, what?

The trick

Here it comes: instead of using his salary to pay the whole 27k, he is only covering the interests with his salary. Only the 10k. The other 17k (the amortisation) comes from an increase of his Lombard loan. Benny is borrowing money from his broker to give it to the bank. By doing that, he has 8k that he can add to his investment portfolio. Assuming 7% growth of his original 200k portfolio, he now owns 222k (200*1.07+8) of stocks and owes 67 (the original 50+the additional 17). His debt ratio has therefore increased from 25% to 30%. Year after year, his interest payments increase (because he’s paying 1% debt by borrowing at 2%) so his contributions to his stock portfolio decrease. His debt ration increases year after year, peaks around 45% and then slightly decreases every year, because the appreciation of the portfolio takes over.

After 15 years, Benny owns a 700k portfolio with a 300k loan attached to it. His 3rd pillar grew from 50 to 138. And he owns a one million property with a 650k mortgage.

All in all, Benny’s net worth is more than 100k higher than Alfred’s. And that, in just 15 years, doing essentially the same thing.

But what to do of the huge Lombard loan? One possibility is just leave it as is: pay interest on it between now and Judgement Day. Another possibility is to have the property reevaluated and take a reverse mortgage from the bank to pay back the Lombard loan. Here is how it works: let’s say that after 15 years, the 1 million property is actually worth 1.3 million. Benny suddenly owns 50% of the new equity (since the mortgage is 50% of the value of the house). Now he can go to his bank and request a reverse mortgage: he can borrow up to 195k (15% of the new value of the house) from the bank at the same rate than his mortgage and use that money to pay back part of his Lombard loan. In this case, he’s substituting a 2% loan for a 1% loan, cutting his interest payments in half.

Why you shouldn’t do it

Now… if you’ve followed me so far, you must know that this plan has a few caveats. It’s actually a very risky plan, that no one in his right mind should implement.

The main risk is the margin call. The stock market doesn’t grow 7% per year every year. That number is just an average. It can be +30% one year and -50% the next. So what happens when the value of the portfolio dips significantly? The broker either asks for more cash (collateral) or directly sells part of the investment. That’s obviously… suboptimal given that the shares would have lost a good chunk of their value. The margin call trigger conditions vary from broker to broker and also depend on your stock portfolio. Don’t implement this strategy unless you have a complete understanding of the conditions triggering a margin call.

One way to mitigate the risk of margin call is to actively contribute to the portfolio to keep the debt ratio to a minimum. If, instead of investing only 8k per year, Benny could invest 30k per year, his debt ratio would peak at 30%, which starts to be within reason. Another way is to start with a much lower debt ratio.

The other risk is that the broker can change the conditions of the loan at any time. Either by changing the margin requirements, even if there is no drop in the value of the portfolio. Or simply by changing the interest rate. 2% interest seems attractive but 5% starts to hurt.

To conclude, I will say this: this is crazy, don’t do it. It works on paper. I’d like to think that it’s pretty clever. But it’s so risky that it starts being stupid. Unless you enjoy living on the edge, and you’re willing to bet all your money on red.