Requirements for Credit Approval
To be granted a mortgage in Switzerland, potential buyers must meet various requirements that ensure their financial stability and minimize the risk for lenders:
Equity
Borrowers must contribute at least 20% of the home’s purchase price as equity. At least 10% of this must come from sources other than the pension fund (2nd pillar). These so-called hard equity funds can be either account balances or funds from the third pillar.
Excerpt: Use of Pension Funds – Withdrawal vs. Pledging
In Switzerland, pension funds from the 2nd and 3rd pillars can be used to finance homeownership in two ways: by withdrawal or pledging. Both options offer different benefits and should be chosen based on your personal financial situation.
Withdrawal of pension funds:
- When withdrawing, funds are taken directly from your pension fund (2nd pillar) or tied provision (3rd pillar) to finance the equity.
- These funds are deducted from your pension account, thus reducing the capital available at retirement.
- Withdrawal is taxable, although the tax rate is often more favorable than the normal income tax rate, as the capital is taxed separately as a one-time income.
Pledging of pension funds:
- With pledging, the capital remains in the pension institution, but you use it as security for the mortgage loan.
- This increases your creditworthiness and can lead to better credit terms without reducing your pension capital.
- The pledged funds remain invested, meaning they can continue to generate returns and the full pension capital is available at retirement.
- There are no taxes for pledging since no capital is withdrawn.
Decision-making:
Choosing between withdrawal and pledging of pension funds depends on several factors:
- Tax situation: Do you want to accept the immediate tax burden of a withdrawal, or do you prefer a tax-neutral pledging?
- Financial future planning: Is it more important to maximize your pension capital for retirement, or do you need more liquidity for your immediate equity?
- Credit conditions: Sometimes the additional security offered by pledging can lead to better mortgage conditions.
It is important to carefully review both options and possibly consult with a financial expert to make the best decision for your individual situation.
Affordability
The monthly costs for the mortgage (interest, amortization, ancillary costs) must not exceed one-third of the gross household income. This ensures that the borrower can still afford the mortgage even in the event of possible interest rate increases or changes in income.
Hypothetical Interest Rate:
Banks use a hypothetical interest rate that is higher than the current interest rate to test affordability. This is often around 5%, meaning affordability must be ensured even under less favorable interest conditions.
Amortization
The mortgage must generally be paid down to two-thirds by the time you reach retirement age (usually 65 years). This means that at least 15% of the loan amount must be amortized within the first 15 years after the loan is taken out.
Excerpt: Indirect Amortization
Indirect amortization is a popular method in Switzerland to reduce mortgage debt within home financing without affecting the borrower’s liquidity. This method has specific advantages and features that make it particularly attractive.
Functionality:
- In indirect amortization, the loan itself is not repaid directly during the term. Instead, the borrower pays contributions into his tied provision, usually the 3rd pillar or a special life insurance. These payments build up capital that is used at the end of the term or at an agreed time to repay the mortgage loan partially or fully.
Advantages
- Tax efficiency: Contributions to the 3rd pillar are deductible from taxable income up to an annually fixed maximum amount, which means an immediate tax saving.
- Preservation of provisions: Since the money flows into the provision institution, the capital is preserved and benefits from capital formation, which is particularly advantageous when returns are higher than mortgage interest rates.
- Flexibility: Compared to direct amortization, where the mortgage debt is directly reduced, indirect amortization offers more flexibility regarding the availability of funds.
Considerations:
Indirect amortization is ideal for those who want to optimize their tax burden while also preparing for retirement. However, it is important that the return on the provision investments exceeds the cost of the mortgage to realize a financial benefit.
Example: Suppose you have a mortgage of CHF 500,000. Instead of investing CHF 5,000 annually directly into the mortgage, you pay this amount into your 3rd pillar. Over the years, this capital grows through compound interest. At the end of the term, you use the accumulated capital to pay off part of your mortgage.
Creditworthiness Check
Banks conduct a thorough creditworthiness check to assess creditworthiness. This includes checking income conditions, existing debts, and past credit history.
Simple Calculation Example for Loan-to-Value and Affordability
Let’s say you want to buy a property and are considering a purchase price of CHF 800,000. The bank requires you to bring at least 20% (CHF 160,000) as equity. Up to CHF 80,000 of this can come from your pension fund (2nd pillar). The remaining equity (CHF 40,000) must be bank balances or from your 3rd pillar.
For the affordability calculation with a hypothetical interest rate of 5% and assumed ancillary costs of 1% of the purchase price per year, the following calculation would result:
- Annual interest expense: 5% of CHF 640,000 (80% of CHF 800,000) = CHF 32,000
- Annual amortization: 1% of CHF 640,000 (to amortize at least 15% in 15 years) = CHF 6,400
- Annual ancillary costs: 1% of CHF 800,000 = CHF 8,000
- Total annual housing costs: CHF 46,400
These costs must be less than one-third of your annual gross income. Therefore, a minimum gross income of CHF 139,200 (CHF 46,400 * 3) is required for affordability.
Financing Types: Fixed-Rate Mortgage vs. SARON Mortgage
When purchasing a home in Switzerland, you have the option of choosing between a fixed-rate mortgage and a SARON mortgage, among others. Both have specific characteristics that make them suitable for different financial situations and risk profiles:
Fixed-Rate Mortgage:
- Interest rate: The interest rate of a fixed-rate mortgage is set for the entire term, which typically ranges from 2 to 10 years. This provides high planning security regarding future payments.
- Predictability: Since the interest rate is fixed, the monthly mortgage payments are constant. This facilitates household budgeting, especially in an interest rate environment that is expected to rise.
- Security: A fixed-rate mortgage is ideal for borrowers who want to minimize risks and have accurate predictions of their finances over the years.
SARON Mortgage:
- Interest rate: SARON (Swiss Average Rate Overnight) refers to an average overnight interest rate in the Swiss interbank market. The interest on a SARON mortgage is adjusted regularly, often quarterly, which can lead to fluctuations in payments.
- Flexibility: This type of mortgage offers greater flexibility in terms of interest rate development. If the market interest rate is low, borrowers benefit from lower payments.
- Risk: The SARON mortgage carries the risk of rising interest rates, which can lead to higher costs over time. It is suitable for borrowers who are willing to take advantage of market fluctuations and can financially handle potential interest rate increases.
Decision Aid:
The choice between a fixed-rate mortgage and a SARON mortgage largely depends on your personal risk tolerance and financial flexibility. A fixed-rate mortgage offers security and predictability, while a SARON mortgage potentially offers lower costs but is associated with higher risk. In any case, it is worth discussing your personal situation and starting point with an expert.
Legal Aspects of Home Financing in Switzerland
The legal framework for mortgage lending in Switzerland is carefully designed to balance the protection of both lenders and borrowers. Here are some key points of this legal structure:
Debenture: A key security instrument in mortgage financing. The debenture is a document that entitles the holder to a certain sum of money against the property and is registered in the land register. In the event of a payment default, the debenture gives the lender the right to satisfy itself from the value of the property. This instrument can be used for both fixed and variable rate mortgages and is transferable, which allows for high flexibility in credit management.
Land Registry Entry: All rights to real estate and mortgages must be registered in the land register. These entries are publicly accessible and provide transparency about all legal relationships affecting a property. The registration not only secures the lender but also protects the borrower from unjustified claims by third parties.
Regulation and Supervision: Swiss financial market authorities regulate and monitor the mortgage markets
