With retirement it’s such a thing. In principle, one works towards it one’s entire life and in most cases, one looks forward to all that newly gained free time. But retirement brings with itself also a number of changes and poses demands on making some rather significant decisions that may have long-term consequences.
One of these decisions concerns handling one’s real estate which very likely entails a mortgage on it. At the time of retirement, the second mortgage, in vastly most cases, has already been amortized while the first mortgage usually remains. This situation is quite common in Switzerland.
At this point then, the question arises, how the mortgage burden is to be managed. Is an amortisation of the remaining mortgage worthwhile? If so, to what extent and with what means?
Amortization may give an appearance of an immediate positive effect. The debt is getting smaller and with it the annual mortgage interest is reduced or disappears altogether. However, ownership of residential property in Switzerland also carries and imputed rental income, a notional amount in fact, but resulting in an additional income tax. If the mortgage interest burden is lower, paying off the mortgage would imply increase of the tax burden. Furthermore, the question arises, with what means amortization makes sense and if it is possible in the first place. Should liquid funds or pension assets from the second or third pillar be used, the obvious corollary is that they will not be available for later income flows.
The lender may also demand a payoff of the mortgage. This mostly happens not because of the pledged value of property (less than 65%), but because of the financial sustainability issue arising in a new situation when in retirement.
A widely applied is the “one third rule” according to which imputed housing costs may not exceed one third of the income. So far so good. But what does this imply after retirement? The income flows from AHV (the pay-as-you-go solidarity part of the social insurance) and pension fund benefits (capital coverage part) are usually much lower than the original earned income. In case of a partial capital withdrawal from the pension fund assets, this situation will be exacerbated. On the other hand, the imputed interest rates are calculated with today’s astronomical high 5%. In addition, 1% maintenance / incidental costs are based on the market value of the property.
Let us consider a single-family home in the canton of Zurich with a market value of 1.5 million francs and a mortgage burden of 650,000 francs. The resulting imputed housing costs are 47,500 francs with further implication of a pension income of CHF 142,500 to be generated – certainly a sumptuous amount.
Yet another issue to be considered are potential claims of the heirs. If amortization is carried out with liquid funds, this can lead to insufficient liquidity in the event of subsequent inheritance in order to pay out all the children, if necessary. In the worst-case scenario, this can lead to the property selloff in order to meet all the demands.
In light of the above deliberations it should be apparent that taking precautionary measures regarding the mortgage burden is definitely worth a while. Only by assuming a holistic and timely approach can later problems be identified and resolved ahead of time.
Written by:
Konstantin Wyser | Partner
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