Financing your own home: The basic principles of financing your own home

Financing your own home: The most important basic principles.

Very few buyers are able to fully finance their own homes up front, so if you want to purchase a house or an apartment, you will usually need external financing in the form of a mortgage. The equity portion can be saved up, for example, or raised by pledging pension capital. We explain the most important basic principles on the subject of financing homeownership.

What is a mortgage?

A mortgage is a loan secured with real estate. In other words, when a mortgage is concluded, the mortgage holder borrows money from the bank at a specific interest rate to buy the property. The bank then receives a mortgage note for the property as collateral.

What is the market value of a property?

The basis for the calculation of a mortgage is the "market value" of the property. The market value refers to an estimated price that would be obtained by properties of the same or similar size, location, and quality in the area in question under normal market conditions.

The purchase price and the market value are normally identical. Due to high demand for home ownership in the Swiss real estate market, however, there may be times when the purchase price for the property exceeds the market value. The difference between the two values cannot be covered with a mortgage and must instead be paid by buyers themselves.

A brief explanation of first and second mortgages

The amount of the mortgage is based on the mortgage holder's financing needs and may total up to a maximum of 80% of the market value. Due to varying repayment rules, a distinction is made between the first mortgage with a loan-to-value ratio of up to 67% and the second mortgage with a loan-to-value ratio of between 67% and 80%. The exact percentages may vary slightly depending on the bank and the product.

This theoretical distinction between the two types of mortgage does not, however, mean that a loan necessarily has to be concluded in two tranches in practice. The mortgage can be subdivided independently of the first and second mortgages. The remaining amount must be paid by the buyers using their own equity capital.

What is equity capital?

Equity capital (or just equity) is the capital that must be raised by the buyers themselves when financing a property. It must account for at least 20% of the property value, as a maximum of 80% of the property value may be financed externally.

Of this 20% equity capital, at least 10% must be "hard equity capital." This encompasses account balances and savings, securities, Pillar 3a pension capital, surrender values for insurance policies, gifts, and inheritances. The remaining equity capital can be "soft equity capital," i.e. withdrawals or pledges of pension fund assets.

Video: Equity capital and debt capital in a nutshell

Watch this video to find out what can be used as equity capital.

Source: Credit Suisse

What sort of mortgage is most appropriate?

Mortgages are not "one size fits all" – in fact, there are a number of different mortgage models with differing conditions. Some offer an interest rate that is fixed over a period of multiple years, while others adapt to current interest rate levels on an ongoing basis. The decision regarding what sort of mortgage is most appropriate for prospective owners depends on whether they are wanting to err on the side of caution or whether they are willing to accept fluctuations and in doing so potentially benefit from lower interest rates.

When taking out a mortgage, it is recommended that you discuss your financial situation and options with a financing expert. This will help you to find the best mortgage to finance the home you want to buy.

Fixed-rate mortgage

Fixed-rate mortgages generally have a term ranging from 2 to 15 years with a fixed mortgage interest rate and a fixed repayment amount. This allows you to hedge against rising interest rates, making it easier to budget.

With fixed-rate mortgages, some lenders also offer to set the mortgage interest rate in advance – this can be done up to three years before the disbursement of a new mortgage or the extension of an existing mortgage. These mortgages are often referred to as forward mortgages.

The Fix mortgage and the Forward Fix mortgage from Credit Suisse are both fixed-rate mortgages.

Adjustable-rate mortgage

Unlike fixed-rate mortgages, adjustable-rate mortgages—as the name suggests—have an adjustable interest rate and change in response to market conditions. The benefit for you: You have no fixed term and no fixed interest rate. This does make it more difficult to plan, however, and your mortgage costs could increase if interest rates rise.

Credit Suisse also offers an adjustable-rate mortgage.

SARON mortgage or money market mortgage

Money market mortgages also offer an adjustable interest rate – one specifically linked to the SARON. The abbreviation SARON stands for Swiss Average Rate Overnight and is a SIX Swiss Exchange reference interest rate for the Swiss franc that tracks closely to the official policy rate of the Swiss National Bank. Money market mortgages are therefore also known in Switzerland as SARON mortgages. Details of the current SARON interest rate from the SNB can be found here.

The mortgage interest rate for the SARON mortgage is made up of an amount that is linked to the reference interest rate and a lender-specific amount. The interest rate is usually announced retroactively at the end of the accounting period of one to three months. The term is one, two, or three years.

SARON mortgages are particularly suitable when falling interest rates are expected on the money market. When rates are rising, however, high mortgage costs can be expected.

The Credit Suisse money market mortgages are SARON mortgages and SARON rollover mortgages. The latter are suitable for those who want to know the mortgage interest rate at the start of the mortgage tranche. 

What is promotion of home ownership?

If you do not have sufficient equity, promotion of home ownership can be a useful option for increasing equity capital and turning the dream of your own home into a reality.

Advance withdrawals and pledging from retirement provision, i.e. the second pillar and Pillar 3a can also be used to purchase your own home. These options are classified as promotion of home ownership and are subject to detailed rules that you need to be aware of.

For example, you can withdraw all your funds from your pension fund until you reach the age of 50; after that, the amount you can withdraw is capped. In the case of Pillar 3a, you can withdraw all your assets regardless of age. Withdrawals from both pillars are only possible every five years. Pledging assets is also an option.

However, advance withdrawals from the second pillar and Pillar 3a can also have a downside. This is because withdrawing the amount means it will be missing from your retirement provision later. Death and disability benefits may also be reduced in some cases. For this reason, it is crucial to make plans with the future in mind.

Confirming long-term affordability

In order to take out a mortgage for their dream home, buyers must have an adequate level of regular income – in addition to the 20% equity capital – to ensure the financial affordability of the property. What this means is that the imputed housing costs such as mortgage interest, repayments, maintenance and ancillary costs must not amount to more than one-third of gross income. To be on the safe side, however, most banks typically assume a long-term average interest rate of 5%, the "imputed interest rate." This is done in the interest of ensuring that the mortgage remains affordable for homeowners over the long term – even in the event of rising interest rates.

Video: Equity capital and the affordability of mortgages – explained simply and succinctly

Anyone wishing to buy their own home is faced with the issue of how much equity capital must be or should be provided and the extent to which affordability influences financing. This video explains the important things to note when pledging pension capital and how this differs from advance withdrawal.

Source: Credit Suisse

How does repayment work?

The costs for repaying the mortgage to the bank are a key element of the affordability calculation. Mortgages with a loan-to-value ratio of up to 67% are considered first mortgages and do not necessarily have to be repaid – unless the financial situation requires this. Accordingly, it is important for mortgage holders to weigh up the factors for and against repayment: The interest rate decreases with each repayment, for instance, and the debt ratio decreases. At the same time, however, debt repayment may not be the best option in consideration of tax factors and missed opportunities for returns.

A repayment obligation does apply, however, for amounts above the 67% threshold, i.e. for the difference between that and the maximum possible loan-to-value ratio of 80%. Referred to as the second mortgage, this amount must be repaid within 15 years or, in the case of mortgage holders over the age of 50, by the time they retire. There are two variants here: direct repayment and indirect repayment.

With direct repayment, the mortgage is repaid to the bank in regular installments. The mortgage debt and the interest payments decrease continuously with this approach. At the same time, the tax burden increases, since the tax deductible reduces accordingly.

With indirect repayment, the mortgage remains the same throughout its term. This is because the payment is first made to a Pillar 3a pension account or safekeeping account and is then transferred to the bank at a later date and thus repaid.

Video: A short and simple guide to mortgage repayment

When you finance your home, planning the repayments is an important factor. This video explains what you need to keep in mind and what the pros and cons of direct and indirect repayment are.

Source: Credit Suisse

Do you have any questions about financing your dream home?

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