Repay your mortgage or invest?

Purchasing a property is a major milestone that quickly raises the question of which long-term repayment strategy is the most appropriate.

• In Switzerland, if your mortgage debt exceeds 65% of the property's value, you are required to repay part of the mortgage so that the debt is reduced to this threshold within 15 years.

• Because mortgage interest is deductible from your taxable income, maintaining a certain level of debt may, somewhat paradoxically, be financially advantageous depending on your tax bracket.

• Every franc used to reduce your mortgage is a franc that is no longer invested in the financial markets, where potential returns may exceed the cost of your mortgage interest.

How Does Mortgage Amortization Work?

In Switzerland, most mortgages are divided into two tranches:

• The first mortgage generally covers up to 65% of the property's lending value and does not have to be repaid.

• The second mortgage, which completes the financing (typically up to 80% of the property's value), must be amortized.

Mortgage amortization generally begins as soon as the loan is granted. From the bank's perspective, the objective is to ensure that the homeowner builds up sufficient equity, thereby reducing the lender's risk should the real estate market decline.

For homeowners, amortization is a way to increase their equity in the property while gradually reducing the amount of interest paid over time.

Direct vs. Indirect Mortgage Amortization: How Do They Work?

Two main repayment methods are commonly used:

• Constant repayment (annuity): The total monthly payment remains the same, but its composition changes over time (more interest at the beginning, more principal towards the end).

• Linear repayment: The amount of principal repaid remains constant, resulting in progressively lower monthly payments over time.

Direct Amortization

With direct amortization, you periodically (every quarter or every six months) pay an agreed amount directly to your lender, thereby reducing the outstanding mortgage balance.

• How it works: Your mortgage debt decreases with every payment. As a result, your interest costs gradually decline because they are calculated on an increasingly smaller outstanding balance.

• Financial advantage: You improve your financial security by steadily reducing your actual debt. This visible deleveraging strategy gradually lowers your monthly housing costs.

• Tax impact: Since your mortgage debt decreases, the amount of deductible mortgage interest also falls. Consequently, your taxable income increases, which may result in higher taxes.

Indirect Amortization

With indirect amortization, you do not repay the bank directly. Instead, your contributions are paid into a restricted pension savings account (Pillar 3a) pledged to the lender. The accumulated capital is then used to repay the mortgage in a single payment.

• How it works: Your mortgage balance remains unchanged throughout the loan term. The savings accumulated in your pension account are used to repay the mortgage, no later than at retirement.

• Financial advantage: Funds invested through Pillar 3a may be invested in securities, offering the potential for returns that are often higher than your mortgage interest rate.

• Tax impact: You benefit from a double tax advantage: you retain the full deduction of your mortgage interest while also deducting your Pillar 3a contributions from your taxable income.

Comparison Table: Direct vs. Indirect Mortgage Amortization

Should You Repay Your Mortgage or Invest Instead?

The choice between repaying your mortgage and investing your available capital depends on your risk tolerance, your tax situation and the prevailing interest rate environment.

Repaying Your Mortgage for Greater Peace of Mind

Homeowners with a more conservative risk profile will generally prefer to amortize their mortgage.

• Protection against rising interest rates: A lower level of debt provides greater financial security when it comes time to renew your mortgage if market interest rates increase.

• A guaranteed net return: Repaying your mortgage is equivalent to making a risk-free investment with a return equal to the mortgage interest you no longer have to pay.

• Financial security in retirement: Entering retirement with minimal mortgage debt helps offset the usual reduction in income by significantly lowering housing expenses.

Investing Instead

If you have a higher tolerance for risk, investing your available capital may prove more profitable over a 15- or 20-year horizon than repaying your mortgage.

• The financial leverage effect: If the expected return of a diversified investment portfolio exceeds the cost of your mortgage, you can build wealth by using the bank's money.

• Liquidity: Money invested in financial markets remains accessible, unlike capital tied up in your home, which generally requires increasing your mortgage in order to be released.

• Portfolio diversification: Holding financial investments alongside your property helps ensure that your wealth is not concentrated solely in real estate.

How Should You Decide?

To make an objective decision, it is advisable to compare the expected financial performance of both options. The two key factors to evaluate are:

• The net cost of your mortgage: This is your effective mortgage interest rate after taking into account the tax savings generated by deductible mortgage interest.

• The net return on your investments: This corresponds to your investment performance after deducting taxes on dividends and wealth tax.

FAQ

Is it mandatory to repay your entire mortgage in Switzerland?

Unlike in many other countries, it is common in Switzerland to keep the first mortgage (up to 65% of the property's value) indefinitely. This allows homeowners to continue benefiting from valuable tax deductions throughout their ownership.

How does the imputed rental value affect my decision?

The imputed rental value is a notional income added to your taxable income. To offset this tax burden, Swiss tax law allows you to deduct your mortgage interest payments. If you fully repay your mortgage, you will still be taxed on the imputed rental value but will no longer benefit from mortgage interest deductions, potentially increasing your tax bill.

Can I change my repayment method later?

Yes. It is generally possible to switch from direct to indirect amortization, or vice versa when renewing your mortgage or with your bank's approval. However, doing so may require adjustments to your retirement savings arrangements.

When is direct amortization the better option?

Direct amortization is generally recommended if you want to reduce your monthly housing costs as quickly as possible or if you are in a relatively low tax bracket, where the tax benefits of mortgage interest deductions are limited compared with the interest savings generated by reducing your debt.

Is Pillar 3a the only option for indirect amortization?

Pillar 3a is by far the most common solution because of its significant tax advantages. However, in certain situations, a Pillar 3b life insurance policy may also be used, although its tax treatment differs and is generally less advantageous for current taxable income.