Mortgage loan and rising rates: should you amortize or renew your mortgage?
It is a reality that the rise in inflation and the tightening of monetary policy of the Swiss National Bank have a significant impact on mortgage rates, which have taken the path of a sudden increase. This is how, for example, the 10-year fixed rate went from 1.1% a year ago to around 2.7% today, for the best offers.
Applied to a 1 minute debt, the monthly cost of debt service therefore increases from CHF 916.- to CHF 2250.-, an increase of 145% in the cost of money!
Many of our clients have asked us whether to refinance or amortize their debt. The answer, as is often the case with the cases we handle, is that it all depends on your personal circumstances.
We therefore propose below an approach to answer this thorny question.
Of course, the first criterion is to know the means you have available to amortize all or part of your debt. Among the latter are of course your "free" savings, but also your "compulsory" savings housed in your provident fund, or even your assets accumulated in a 3a account or even life insurance.
Amortize my debt with my free savings?
If you can afford it, the main decision criteria are quite simple: is the return you expect on your investments higher than the cost of your mortgage debt, after taxes? Does your risk sensitivity allow you to assume the risks associated with leverage?
We illustrate these elements below.
In Switzerland, passive interest is generally deductible from taxable income. The return on your assets, on the other hand, is taxed differently between income (bond coupons and dividends, rental value, see net rents if the object is rented, which are taxed with your other income) and capital gains on securities (not taxed, in principle).
We will also remember that maintaining any debt to increase its participation in various forms of investments generates a leverage effect, very favorable on the upside but potentially devastating on the downside.
We illustrate this element with an example which does not include the tax impacts cited above: an investment of 100.- is financed for 60.- by equity and 40.- by debt. The cost of debt is 3%. If your investment produces a return of +6%, your net return will be CHF 6.-less CHF 1.20 (for debt service), or CHF 4.80. Relative to your initial equity of CHF 60, the return is 7.7%.
Conversely, if your investment produces a result of -6%, the value of your equity will then drop by 8.3%. If the value of your investment drops by 58.8% you will have completely lost your equity!
Use my pension fund to pay off my mortgage?
It will be recalled that the LPP authorizes the withdrawal of pension fund assets for the financing or repayment of the mortgage debt of one's main residence. The rule is that an insured person can withdraw from their pension fund the higher value between having accumulated it at age 50 or half of their total pension assets.
But that is only half the story, because it is also possible to consider an indirect amortization program for your mortgage through redemptions of pension years, if this reserve exists, and/or contributions to an account of 3e pillar.
We examine these avenues below, specifying that in such cases the tax dimension takes on preponderant importance.
An outflow of pension assets is envisaged to amortize the mortgage.
The capital outflow of all or part of the pension assets is taxed at rates ranging from 5% to 25% depending on the cantons (around 9% for Geneva and Vaud). Once all or part of the debt is repaid, wealth tax will increase proportionately and passive interest deductible from taxable income will disappear (and therefore income taxes will increase). In addition, your pension capital will be less and the (tax-free) income allocated to it will be proportionally lower. This also results in a more modest target pension capital for retirement. Finally, early withdrawal blocks any possibility of redemption that may exist in the future, with capital withdrawn for housing first having to be "repaid" to the pension foundation, before it can be qualified as redemption and benefit from deductions corresponding taxes.
Possibilities for pension buybacks still exist :
it is generally appropriate to favor the repurchase strategy over that of amortizing the mortgage debt, even if it means planning for subsequent amortization of this debt, generally at the time of retirement. The subtleties for mastering such an approach are numerous and cannot be described in this letter. It will be remembered, however, that a redemption is deductible from taxable income and that the effect of this deduction must be calculated at the marginal tax rate of the person concerned, which can rise up to 45% depending on the taxable income of the household and his canton of residence. In addition, the capital repurchased is no longer subject to wealth tax or capital income tax, while the interest on the mortgage debt is deductible from taxable income and the amount of the debt is deducted from the wealth taxable. This is a complex setup, but one that can lead to very significant savings.
I refinance. But at what maturity?
In recent years, the Swiss have preferred to lock in their mortgage rates over long periods, often 10 years, to benefit from the ultra-competitive rate environment and ensure their budgetary security.
Today the situation is different: the average 10-year rate varies from 2.7 to 3.5% depending on the Bank, while the Saron rate (rate indexed to the evolution of the money market) varies between 0.60 and 1.60%. The difference is therefore substantial, but of course Saron does not protect you in the event of a lasting increase in rates.
So what to choose?
Let's use a numerical example to illustrate the situation: let's take the hypothesis of a 1 minute mortgage, a fixed rate over 10 years of 3.1% and a Saron rate today of 1.1%. We can then calculate the annual cost of servicing the debt. For Saron we will hypothesize strong variations: in year 2 this rate would increase to 3.2%, then in the following years to 6%, 5.2%, 4%, 3%, 2%, 1.5%, 1.5%, 2% (this is a bit of a disaster scenario in the event of persistent inflation).
The annual charge will be as follows (in CHF):
Two lessons can be learned from this table:
- Your cash flow must be sufficient to be able to cope with sharp rate increases, if you opt for Saron
- Ultimately it is the total cost of servicing the debt that must be considered. In our somewhat extreme example, the difference is CHF 13,000.- in favor of Saron (without present value of flows).
Conclusion
As we can see, the question of the strategy for refinancing a mortgage debt is much more complex than it seems. And decisions taken lightly can be very costly when you combine their effects over long periods of time.
And there are plenty of small (and big) subtleties that it hasn't been possible to address in this document.
It therefore seems essential to us to include this decision within the framework of an overall asset assessment, which also takes into account long-term life projects, in particular retirement, a time when the conditions for granting or maintaining of a mortgage can change a lot.
