Nowadays, few homeowners have the luxury of buying a property without taking out a mortgage. A mortgage loan can easily run into several hundred thousand Swiss francs, and must be gradually paid back. This repayment process, also known as amortisation, is arranged when the mortgage is set up, according to the requirements of the lender (usually a bank, insurance company or pension fund) and following the rules governing the mortgage market. These rules state that the mortgage must be brought down to two thirds (around 67%) of the debt’s collateral value (security provided in exchange for a loan) during the first 15 years by making regular repayments.
Purchase price: 1 million francs
Deposit: 200,000 francs (20% of the purchase price)
Debt: 800,000 francs
Collateral value: 1 million francs (unless the market value falls, in which case the lowest value applies)
After 15 years, the debt must have been reduced to 67% of 1 million = 670,000 francs.
Minimum repayment over 15 years: 130,000 francs. Purchase price minus deposit equals 67% of the collateral value (1,000,000 – 200,000 – 670,000)
Minimum annual repayment during the first 15 years: 8,667 francs.
In Switzerland, buyers have two options when taking out a mortgage: direct and indirect repayment. Direct repayment means the debtor makes their annual repayment directly to their creditor (bank, insurance company, etc.). The advantage of this is that the buyer reduces their debt year on year, and lowers their interest payments accordingly. However, this saving is somewhat lessened by the current low interest rates, and the buyer cannot enjoy the benefits of indirect repayment, such as tax advantages.
Why choose indirect repayment ?
Indirect repayment fixes the debt amount and the resulting financial costs for the entire term of the contract. There is no repayment of the debt, which stays at the same level, as does the interest. This situation offers several advantages. The first is that it enables the borrower to lock the repayment into a savings account and earn interest on the invested sum. The second is the tax deductions: the debt amount is deductible from their personal wealth whereas the interest paid is deductible from their taxable income. At the end of the contract, the invested sum provides security for the bank, which uses it to repay the debt.
There are two ways to set up indirect repayment:
● by opening a Pillar 3 bank account (Pillar 3a);
● by arranging a Pillar 3 pension tied to a life insurance policy (a or b).
Note: Pillar 3 refers to a whole range of financial planning solutions that enjoy tax advantages, and is divided into two categories, tied and flexible:
Pillar 3a (tied) is for people working in Switzerland and enables them to build up a nest egg through tax-exempt, capped payments (in 2017: 6,768 francs for an employee, 33,840 francs for a self-employed person not making contributions to a Pillar 2 affiliated pension fund).
flexible Pillar 3 covers a very wide range of income insurance products (life insurance, life annuity, etc.) that enjoy tax deductions on a cantonal basis (the rules vary from one Swiss canton to another). This system is much more flexible than Pillar 3 but is not always quite as tax-efficient.
Pillar 3 tied bank account (3a)
The Pillar 3 tied bank account is a savings account where the annual payments are capped (at 6,768 francs per year in 2017 for an employee, 33,860 francs for a self-employed person with no pension fund). It cannot be used to cover annual repayments exceeding these amounts. However, it provides a cash reserve which can be used to pay for improvements to make the property more energy-efficient (insulation, windows, renewable energy, etc.).
The account is emptied by the bank regularly on a contractual basis (every five years, for example) in order to make the repayment. This action is considered as a withdrawal by the Swiss tax authorities and is liable for tax under preferential conditions. The tax bill depends on the taxable income of the person making the withdrawal and the place of domicile.
- Annual payment: 6,768 francs (as of 2017). The amounts increase by a few francs each year.
- Sum after 20 years: 135,360 francs at least (the total depends on the increase in permitted caps)
- Sum at the end of the contract: 135,360 francs + increase in permitted payments + cumulative returns on the assets for the term of the contract
Pillar 3 can be linked to investment products like investment funds and exchange-traded funds (ETF). The asset therefore changes in value along with the underlying instruments. If the latter increases (for example in a rising market), the value of the account increases too, but the reverse can also happen. This type of investment therefore carries a greater risk than Pillar 3b.
Borrowers do not have to invest their Pillar 3 funds in financial products, but can treat it as a locked savings account with a slightly higher interest rate than an ordinary savings account (0.5% on average). It is therefore less likely to see its value increase in line with the financial markets, but it is more secure and stable.
3a or 3b life insurance ?
Some lenders also allow amortisation to be guaranteed by a life insurance policy covering the lifetime of the borrower(s). Rather than paying into a bank account, the borrower pays insurance premiums, with payment schedules and amounts varying according to their contract. The asset is further augmented by the return on capital according to the terms of the insurance policy. Last but not least, life insurance also enjoys tax advantages.
The advantage of an insurance policy compared to a Pillar 3 account tied to a bank is that it guards against several risks, including inability to earn, which requires the insurance company to honour the insured party’s premiums. Moreover, 3a bank accounts and 3a insurance policies are not taxed during the term of the contract, only when the capital is released. A 3b insurance policy, on the other hand, is subject to tax on the asset’s commuted value but not after the capital has been released.
- Annual premium of 10,000 francs;
- Term of the contract: 20 years
- Premium sum: 200,000 francs
- Value of the policy upon expiry of the contract: 200,000 francs + total net interest
The policyholder must however take care to ensure that their contract provides for changing interest rates. Due to the negative rates prevailing in Switzerland, interest rates on life insurance policies are extremely low at the moment. If the rate is fixed now for the entire term of the contract, the insured person runs the risk of missing out on any future rise in interest rates.
Indirect repayment is a very handy amortisation tool due to the cash reserve that it creates, and the tax advantages associated with it. However, borrowers should exercise caution and look very carefully at the terms of withdrawal, returns on investments and tax implications for them according to their personal situation and place of domicile.
Would you like more information on this topic? Have you other real estate-related questions? If so, our expert brokers are on-hand and will be delighted to answer your questions and advise you!