Direct or indirect amortisation: Which solution should you choose for your mortgage?

You’re thinking of taking out a mortgage to finance a property project. In Switzerland, only part of the debt has to be repaid: the second mortgage. Most financial institutions offer two solutions for this: direct or indirect repayment. What are the differences, advantages and disadvantages? How do you decide which option is best for you? FGP Swiss & Alps can help you find out.

How do mortgages work in Switzerland?

In Switzerland, a mortgage is granted by a financial institution in return for a guarantee on the property in question. To obtain this loan, you must provide 20% of the purchase price in the form of equity, which means that the bank will lend you 80% of the sum required. The mortgage debt is then divided in two:

• The first mortgage, which does not have to be repaid and represents around 65% of the amount borrowed.
• The second mortgage, which must be repaid within 15 years and no later than retirement (age 65), and which represents around 15% of the total amount.

This breakdown is valid for a standard luxury property in a balanced market.

In short, only the second mortgage needs to be amortised. This can be done in two ways: via direct or indirect amortisation. These are two very different solutions, each with its own advantages and disadvantages.

Direct or indirect depreciation: what are the differences?

Let’s start by distinguishing between the two depreciation options, direct and indirect.

Direct amortisation

With this system, you pay off your mortgage in periodic instalments. All the amounts are deducted from your second mortgage debt. In practice, this means reducing your debt from year to year: for example, if the mortgage is 15% of the purchase price, you pay back 1% of the value of the property each year – in addition to the mortgage interest and maintenance costs. At the same time, interest falls in proportion to the amount of the residual loan.

In this sense, direct repayment has the advantage of being gradual and easy to plan: the amount of debt and interest is reduced over time. On the other hand, the reduction in mortgage debt reduces the interest liability that you can deduct from your tax, which has the effect of increasing your tax burden. What’s more, you’ll need to set aside an additional budget for your private pension provision.

Indirect depreciation

With indirect repayment, instead of repaying the lender year after year, you make payments into a private pension savings plan (pillar 3a: this is usually a life insurance policy pledged for this purpose), the assets of which are pledged as collateral. The amount of the loan is repaid only when the contract expires, by withdrawing the assets from the pillar 3a and transferring them to the financial institution. The purpose of this investment is threefold: to enable you to cover the part of the loan to be repaid, to help you build up private capital, and to cover the risk of death.

No more tax-deductible interest

This has one major consequence, which makes all the difference between direct and indirect amortisation: the debt and the amount of interest remain constant throughout the term of the mortgage. But this is also the main advantage of indirect amortisation, in that mortgage interest is tax-deductible: so you can deduct more interest from your taxable income. In other words, the longer you are in debt, the less tax you pay.

Other advantages of indirect depreciation

When making a choice – direct or indirect repayment – you should also consider the other advantages of deferred repayment:

• Payments made to the savings account are tax deductible up to the specific Pillar 3a annual contribution limits.
• The return on savings is such that the interest generated is often higher than what you pay to the lending institution. The higher the performance of Pillar 3a, the more attractive the indirect amortisation.
• You automatically have third-pillar savings at your disposal, without having to make any additional contributions.
• Mortgage debt is deductible in full from taxable assets.

Disadvantages to bear in mind

On the other hand, your debt and interest charges will not decrease. Payments into pillar 3a are limited (in 2024: a maximum of CHF 7,056 per year for working people with a pension fund – Credit Suisse). When you withdraw your assets, tax applies – but it is lower than income tax. Finally, the fact that your assets are pledged can make it difficult to cancel or refinance a mortgage.

Direct or indirect amortisation: which is the right choice?

Whether you choose direct or indirect amortisation for your second mortgage depends mainly on your situation. It’s true that, for tax reasons, indirect amortisation is often more favourable, especially if you can’t afford to make additional payments into Pillar 3a or another savings plan.

However, this solution only makes sense if the total cost of the loan is lower than that of direct repayment. This means taking into account a number of factors, such as the mortgage interest rate, your marginal tax rate and the return on the investment.

On the other hand, direct amortisation is recommended for owners with high interest costs who want to reduce this burden as quickly as possible.

If you are hesitating between the two options, direct or indirect repayment, ask yourself what is more important to you: growing pension capital and higher tax allowances? Or mortgage debt and lower interest charges?