Between Two Homes: Complex Transitional Financing
If you own your own home, you could be confronted at any time by events that turn into complex financing problems. Cases in point are the purchase of a new home, or the separation of married couples with a joint mortgage. Risk protection is valuable in these instances. However, frequently even this is of no help. The financial barriers often seem insurmountable, as the following example shows.
Beatrice and Claudio live in a rural municipality. When their daughters Anna and Nina were born, they bought a house with six rooms and a large garden in the country. Today, they are both 55 years old; she works part-time as a secretary, he works full-time as a construction specialist. Together, they bring in a gross annual income of 140,000 Swiss francs. Life would be perfect, but since their daughters have moved out of the parental home, things are quiet – too quiet. Beatrice and Claudio feel really lost in their huge house and their rural idyll seems lonely. Claudio, whose company relocated to Wohlen a year ago, has long found the daily, time-consuming commute stressful as well.
Moving from the Country to the Town, from a House into an Apartment
For these reasons, the couple decided to move to a smaller property in the vicinity of Wohlen. The supply of owner-occupied apartments in the conurbation has risen sharply since the start of the construction boom a few years ago.
Claudio has already drawn up a plan to finance the move and intends to fund the purchase of the new property with the proceeds from selling their old home. A sales price of 1 million Swiss francs, less the mortgage of 660,000 Swiss francs, would leave gross proceeds of 340,000 Swiss francs. This, together with a new mortgage, would be enough to pay for the new apartment.
The couple strike it lucky in their search for an apartment. Within a short time, Beatrice and Claudio find a modern 3.5-room apartment for 680,000 Swiss francs just outside Wohlen, which suits their requirements perfectly. The contract is ready for signature, but the transaction looks like it might not go through as the couple are finding it unexpectedly difficult to find a buyer for their old home. The fact of the matter is that they can't sell the house as quickly as they had assumed, at least not at the price they would have liked. Claudio's financial plan is useless.
Sell or Rent Out?
Claudio wants to buy the new property as quickly as possible – if necessary, before selling his old home. But their funds won't stretch to the transitional financing. There's no way the couple can afford two mortgages and Beatrice is skeptical as to whether they're doing the right thing. The situation is complex, and it's causing Claudio a headache. Beatrice and Claudio realize that they have a problem.
Affordable, Even with Two Properties in Play?
For the bank, it is important to clarify the borrowers' financial situation carefully and to reduce the credit risk. For this reason, Credit Suisse uses an imputed interest rate of 5 percent when calculating affordability. In addition to the repayment costs of the second mortgage, 1 percent of the property's value is included in the calculation to reflect the ongoing expense of maintenance and ancillary costs. If the result is not more than one-third of the couple's gross income, Beatrice and Claudio will get the green light: the mortgage is affordable. They will also have the security of being able to afford their property even if interest rates rise. Income and expenditure must also be secured in a sustainable manner, i.e. over the medium term and with reasonable probability.
The Best Solution Bears the Lowest Risk
Although renting out the property has been fully costed, there are still some financial risks with a dual property strategy – in the event of vacancy or the loss of an income stream, for example. For this reason, Credit Suisse recommends that the couple have the property valued, and that they sell it over the medium term. The valuation confirms expectations that the property's value has risen due to its attractive location and connections to the public transport system. The house was purchased for 825,000 Swiss francs in 1996. Since then the land on which it is built has appreciated in value by approximately one quarter. Credit Suisse estimates its current market value to be one million Swiss francs. It should therefore be possible to sell the property within one year at this price. After deducting the existing mortgage of 660,000 Swiss francs and real estate gains tax at 11 percent (tax rate for the Canton of Aargau), approximately 300,000 Swiss francs would be available to the couple as a disposable asset.
There just remains the question of clarifying, by way of precaution, whether the purchase of a replacement property would enable the couple to defer the real estate gains tax. However, as the initial cost of the old house was higher than the price of the new apartment, no replacement purchase can be claimed in this case. Alternatively, the couple should check whether just one of them should purchase the new apartment in order to make a partial claim under the replacement purchase rules.