At the latest at the time of retirement, the collateral for home ownership must be reduced to two-thirds of the maximum market value. The question arises, however, whether it makes sense to reimburse more.
The 80-20 rule is well known as the basis for efficient work: 80% of tasks can be solved with 20% of the total time allocated. This 80-20 rule also finds application in real estate financing: for property for own use, the bank finances a maximum of 80% of the market value, while the remaining 20% must be contributed in the form of equity. We will explain later the link between these two 80-20 rules.
Let’s start with an example: suppose that a property has a market value of one million dollars. In this case, the mortgage loan cannot exceed 800,000 dollars. The sum is divided between a first mortgage (67% of the market value, or 670,000 dollars) and a second mortgage (the remaining 13%, or 130,000 dollars). This division is important for amortization, that is, debt repayment.
Compulsory and optional depreciation
According to the minimum requirements in force of the Swiss Bankers Association, the second mortgage loan must be amortized within 15 years. Many banks, including Migros Bank, also require that this second mortgage be fully repaid upon retirement. To summarize, the practices of the branch in Switzerland provide for a reduction in collateral from 80% to two thirds of the market value within 15 years from the date of purchase, but at the latest at the time of retirement. The first mortgage, which therefore covers the remaining two thirds, is not subject to any amortization obligation.
However, many mortgage debtors are considering additional amortization. First of all for psychological reasons: indeed, one feels better with a lower debt. Then, for reasons related to retirement: income is generally 30% to 40% lower than that of the active period. It is therefore advisable to make additional depreciation in order to improve future financial capacity.
The tax situation generally pleads against optional depreciation
The tax situation plays an important role when deciding on the optimal mortgage amount. Thus, the owners of a home for own use must add to their taxable income the rental value, namely a hypothetical income which would be received if the accommodation was rented to third parties. On the other hand, they can deduct expenses, building maintenance, repairs and interest expense from their taxable income. People subject to high tax increases have little incentive to amortize their mortgages more than necessary. The lower the collateral, the lower the passive interest deductions and the higher the tax payable.
In addition, you have to take into account that by reducing your debt, you pay less interest, but you also have less money to invest and, therefore, lower investment income. A rule of thumb tells us that amortization makes sense when mortgage interest savings are greater than the returns possible from investing in securities or other financial investments, after calculating the tax payable. This tax plays a dual role. Depending on the situation, taxation can on the one hand considerably reduce the returns on a financial investment, and on the other, have a positive effect on debts. Interest expense can indeed be deducted from taxable income, as we have already indicated.
In conclusion: a high mortgage can be wise when a household has to pay a significant part of its income to the taxman. We are talking about marginal tax rates. It expresses the imposition of an additional franc of taxable income, or more precisely to what extent the tax payable decreases for each franc of income less. Take for example a marginal tax rate of 25%: for an initial rate of 1.6%, a fixed rate mortgage only “costs”, after tax, more than 1.2%; the taxes thus allow a saving of mortgage loan of the order of a quarter (see the examples of cases).
Restrictions in case of optional depreciation
If, after weighing the pros and cons, you decide in favor of optional depreciation, you must first clarify the question of the financial leeway necessary to make additional repayments. It should also be borne in mind that, in the context of the amortization of a mortgage loan, a significant part of the inheritance is blocked in the form of a property of the accommodation, and it will take you time and money to make this medium more liquid, for example via a new increase in the mortgage loan.
Finally, the maturity of mortgage loans represents a third restriction on optional repayments. In fact, additional depreciation is most of the time only possible on certain specific dates. This is particularly the case when a fixed-rate mortgage loan matures or when the framework term of a Libor mortgage loan (generally three years) has expired. As for additional amortizations, variable rate mortgages offer the greatest flexibility: it is indeed possible to reduce them by a free amount thanks to their termination period of only six months (and even three months in the Canton of Bern).
In conclusion: depending on your personal situation, it may be wise, according to the 80-20 financing rule, to have less debt and more equity. It is enough to take into account a few points to have considerable optimization possibilities – a typical example of the second 80-20 rule, that of efficiency.