Mortgage repayment – definition, reasons, factors
Repaying a mortgage should be thought through in the long term and adapted to the homeowner's living circumstances. This is because the process is not that simple. Repaying the second mortgage is mandatory, but there is no obligation to repay a first mortgage. In addition, the mortgage can be repaid directly or indirectly. Read this article to find out what this all means and for more information.
The most important points
- What is a repayment?
- How does repayment work?
- Video: Direct and indirect repayment of a mortgage
- The advantages of direct repayment
- The disadvantages of direct repayment
- The advantages of indirect repayment
- The disadvantages of indirect repayment
- When is a repayment worthwhile?
- Reasons to repay a first mortgage
- Reasons against repayment of a first mortgage
Repayment (also known as amortization) is repaying a mortgage to the bank. A distinction is made between the voluntary repayment of the first mortgage and the repayment obligation for the second mortgage.
The first mortgage may not exceed two-thirds of the market value of a property and does not need to be amortized. In addition, the repayment of the first mortgage can only be made without paying any penalties after the end of the term or if an annual repayment was agreed upon at the time the mortgage was taken out. Only with an adjustable-rate mortgage is repayment possible at any time.
The second mortgage, however, that is taken out if a higher loan-to-value ratio is required to finance the property, must be repaid within 15 years or by the time the homeowner turns 65. This is possible directly or indirectly.
The repayment of the second mortgage works in two different ways: directly or indirectly. Based on this, a distinction is thus made between direct and indirect repayment. The right form depends on your personal situation, your financial options, and your tax considerations.
This is how the two options work.
With direct repayment, the mortgage is repaid to the bank in regular installments. As a result, the mortgage debt and the amount of interest payments decrease steadily.
Compared to direct repayment, the mortgage debt remains the same for indirect repayment over the entire term. The payments are transferred into a Pillar 3a pension (securities) account and used to repay the mortgage upon termination.
The main advantages of direct repayment are that you invest directly in your own property and the interest costs for this fall every year, provided that mortgage interest rates remain the same or fall. As a general rule, the higher the mortgage interest, the higher the monthly cost. Interest rates therefore play a key role in determining whether a mortgage should be repaid. In addition, the debt owed due to the mortgage reduces on an ongoing basis. This can also be particularly beneficial for those who want to take things easier during the last few years before retirement and want to reduce their workload. After all, mortgages are nothing other than debt. Many people are uncomfortable with the idea of being in debt. Some property owners also consider a large mortgage to be a burden, since the bank has often financed more than half of their home.
Making regular mortgage repayments to the bank increases your tax burden, as the debts and interest you can deduct from your taxable assets and income are lower. In contrast to indirect repayment, an additional budget may also be required for private pension provision.
The advantage of indirect repayment is that the entire mortgage debt can be deducted from taxable assets over the years, as can mortgage interest from taxable income. Contributions up to the statutory maximum amount may be paid into Pillar 3a annually. These can also be deducted from taxable income. Property owners can therefore make twice the savings when indirectly repaying a mortgage. When the funds for the indirect repayment are withdrawn, the capital saved in Pillar 3a is taxed, but separately and at a lower tax rate. In addition, there are no wealth taxes on pension assets.
There are also interesting securities solutions for Pillar 3a. It is therefore worth having a specialist calculate possible options in order to save on the repayment of the mortgage and optimize it in line with tax and pension requirements.
The payments are not transferred directly to the mortgage account but are indirectly saved in a pension account or Pillar 3a pension securities account. The mortgage debt and the interest burden will therefore remain the same. When the homeowner turns 65, at the latest, the capital is transferred to the bank to repay the second mortgage.
Depending on the investment in Pillar 3a, there may also be charges due to price fluctuations.
As mentioned above, repaying the first mortgage is voluntary. Provided you have enough free capital. However, it is not possible to give a general recommendation on voluntary repayment. You need to consider each factor individually: What is my financial situation? Will I save more if I have to pay less interest, or is this outweighed by the tax benefit due to potential deductions? Can I obtain a higher return with the money than I would save on interest payments?
It's not that easy to weigh all the points against each other. It is therefore worth seeking advice from an expert and taking a closer look at the reasons. An overview.
Those who repay their mortgage indirectly pay less interest.
The higher the mortgage interest, the higher the monthly cost. For example, if you repay CHF 100,000 of your mortgage to the bank at an interest rate of 2.2%, you will save CHF 2,200 per year in interest costs. At an interest rate of 1.2%, this saving would only be CHF 1,200. The higher the interest rate, the more worthwhile it is to repay the mortgage.
Voluntary repayment reduces the debt-to-equity ratio
The value of a property can change. In the best case, it increases over time. However, a property can also lose value. This means that the percentage of the mortgage increases compared to the value of the property, i.e. the debt-to-equity ratio increases. Homeowners can pay off their debt to the bank by means of repayments. This allows them to reduce their personal indebtedness and increase their share in the value of their home.
Debt repayment makes little sense from a tax perspective
Taxes have to be paid on real estate – first on the property as an asset, but also on the imputed rental value, which is added to your taxable income. At the same time, the law allows you to deduct interest on mortgage debt from your taxable income. As a result, it may make sense not to repay a mortgage and thus retain the tax advantages in the form of this potential deduction.
Return opportunities missed due to repayment
If you use your free capital to repay your mortgage, this money is not available for other purposes. In particular, it cannot be invested to obtain a return. The amount of return you miss out on will depend on your personal risk tolerance.
Suppose you invest in equities and achieve an annual return of 3%. This return is larger than the interest rate saving would be if you repaid your mortgage. In this case, you would be worse off by repaying. If, on the other hand, you are more focused on security in your investments and invest in government bonds, for example, or keep your money in a savings account, then the return is much lower. You then benefit more from the interest saved through repayment than from the return on your investments.
Hold onto liquid assets instead of repaying a mortgage
Freely available capital can offer security, especially if you plan on renovating your home or retiring soon. After all, no one can guarantee that you can increase your mortgage once you have repaid it and that the assets tied up in the mortgage will be converted into liquid funds. If you choose not to repay your mortgage, you can cover the financing of renovation with your own funds.
Older people in particular are sometimes glad if they have saved up money that can be used to supplement a small pension. That's why it's not always worth trying to achieve a debt-free house and completely repay the mortgage.