How does mortgage amortization work and is full mortgage repayment a good option?

For most Swiss people, the real estate financing with a mortgage is a great option, especially when interest rates are low. But there are many aspects to take into account. Choosing the right mortgage plan is just the beginning. Then comes the question of amortizing the mortgage loan with an optimized tax burden, which comes with many complexities.

Before concluding a real estate mortgage you must consider the following questions:

• How can I pay off my mortgage?
• What are the tax consequences of depreciation?

Many of our clients who took out a mortgage a few years ago ask us if paying off their loan is useful when they have liquidity. At this point, we strongly advise them to consider the following questions:

• How will paying off the entire mortgage impact my financial situation?
• If I don't repay my loan, how can I use the available capital to get the best possible return?
• When is the right time to pay off my mortgage?

For a real estate investment to be successful, you need a mortgage strategy and the development of a financial plan keeping Swiss real estate taxation in mind, as well as your financial goals. This is where the experts come in.

Take advantage of the independent and transparent advice offered in this article by Impact FE's real estate financial advisors.

What is depreciation?

This is the repayment of a mortgage debt or a loan on real estate. Swiss law provides for two types of mortgages: 1^er and 2^th rank. A mortgage can be amortized or repaid either in full, through regular payments, or in installments.

How do I pay off my mortgage?

Swiss law allows you to finance the acquisition of real estate with a mortgage of up to 80% of the market value determined by the bank, with the exception of second homes.

A 2/3 mortgage or collateral of approximately 65% of this value constitutes a first mortgage. It is not mandatory to amortize senior mortgage debt. You are therefore free to keep it for as long as you wish.  

If financing your home requires more than 65% or two thirds of the value of the property withheld by the bank, you can take out a second mortgage loan which must be repaid in full within 15 years, or at the time of retirement. Second mortgage loans must be amortized.

Repaying your second mortgage loan can be done in 2 ways, namely by direct or indirect depreciation.

If you opt for direct amortization, you repay the loan in installments of a fixed sum, at regular intervals in principle every 3 months. To calculate your annual tranche (over a period of 15 years), simply divide the sum of the debt by 15 then by 4 (for 4 quarters). So, if your second mortgage is CHF 300,000, the annual tranche is CHF 20,000 and the quarterly tranche is CHF 5,000.

In the case of indirect depreciation, the method of payment and payments remain intact. Your payments are not transferred to the mortgagee or the bank, but are deposited into an account in the pillar 3a/b private pension solution. When the pension is dissolved, the amount received is used to amortize the mortgage debt. Funds are not paid directly but remain in your account or deposit and function as security for the lender.  

Both of these strategies can help you establish a good tax plan, but they both have pros and cons. Below we provide you with a table that will help you decide between direct and indirect depreciation.

Amortize directly or indirectly?

Comparing the two strategies, indirect mortgage repayment seems more advantageous than direct amortization. Indeed, as retirement approaches, the capital accumulated via pillar 3a/b makes it possible to reduce the property loan. In addition, this solution promises two tax savings: contributions to private insurance 3a are tax deductible, 3b depending on the cantons, as is mortgage interest until the repayment of the second mortgage.

Our experts will calculate for you the different possibilities of saving the cost of amortizing the mortgage loan and optimizing it in terms of taxation and foresight.

Is paying off the mortgage in full a good option?

The answer to this question cannot be definitive. Amortizing your mortgage requires long-term planning and must be tailored to your lifestyle, age, professional and financial situation.  

But before you decide, you also need to determine:

• the age at which you wish to retire,
• the tax consequences on your finances due to a drop in income,
• your personal projects in the short, medium and long term as well as
• your need for liquidity in the future and your debt ratio.

Concerning voluntary amortization, the first fixed rate mortgage can only be amortized when it matures, or if annual amortization without fees is provided. When the contract expires, you have the option of repaying all or part of the loan, or renewing it. If you wish to repay your fixed mortgage before maturity, you must consult the conditions of your mortgage loan contract. Penalties may be due.

Prepayments can be costly and usually involve paying an exit fee to the creditor or bank for lost interest on money market mortgages. You will need notice of termination, which varies by institution and may also involve a possible penalty. Full amortization of the mortgage loan at any time is only permitted for variable rate mortgages. In this case, the fees are significantly lower than for a fixed rate mortgage loan.

From a tax perspective, full repayment of the mortgage is not always recommended.  

Keeping your home loan may be preferable in particular if investing your free capital elsewhere (government bonds, stocks, savings account, etc.) will bring you better returns over the expected duration of the loan than the interest saved by using funds to pay off your mortgage before maturity. A comparison of the tax impact of your depreciation with different investment solutions (the net return after tax) will prove beneficial. However, this activity can be quite complex and requires calling on a specialist. To choose the right investment options, assess your needs and risk tolerance.  

Available liquidity could also be used to finance gaps in the pension fund upon retirement.

Buying a property is one of life's most important investments, but planning for your future can be difficult with a dependent mortgage. Ideally, you should start thinking about a mortgage at least 10 to 15 years before retirement, during which the loan should be reduced to 65% of the market value of the property. Also note that the theoretical mortgage charge should not exceed a third of your retirement income.

Our amortization specialists are ready to develop a mortgage strategy adapted to your situation and which offers you better financial flexibility by answering all your questions. For more information, contact us from today!