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

You are considering taking out a mortgage loan to finance a property project. In Switzerland, only part of the debt must be repaid: the second mortgage. To this end, most financial institutions propose two distinct solutions: direct mortgage amortization or indirect mortgage amortization. What are their differences, advantages, and disadvantages? How can you determine the most favourable option for your situation? FGP Swiss & Alps helps you see things more clearly.

How does a mortgage loan work in Switzerland?

In Switzerland, a mortgage loan is granted by a financial institution in exchange for a guarantee on the property in question. To obtain such a loan, you must contribute 20% of the purchase price in the form of equity, which means the bank will lend you the remaining 80% of the required sum.

This debt is then divided into two tranches:

• The first-rank mortgage, representing around 65% of the loan, which does not require repayment.
• The second-rank mortgage, representing around 15% of the loan, which must be repaid within 15 years and at the latest upon retirement (65 years old).
  

This structure applies to a standard residential property in a balanced market.

In summary, only the second mortgage must be repaid. Repayment can take two forms: direct mortgage amortization or indirect mortgage amortization. These two methods are fundamentally different and each comes with specific advantages and disadvantages that must be carefully evaluated.

Direct or indirect mortgage amortization: what are the differences?

Let us begin by distinguishing between the two repayment options: direct mortgage amortization and indirect mortgage amortization.

Direct mortgage amortization

With this method, you amortise your mortgage by making regular instalments directly to the lender. Each instalment reduces the balance of your second-rank mortgage. In practice, this means that the debt decreases year after year: for instance, if the second mortgage represents 15% of the purchase price, you repay around 1% of the property value each year, in addition to mortgage interest and maintenance costs.

At the same time, the interest burden decreases proportionally to the reduction of the outstanding debt.

The advantage of direct mortgage amortization lies in its progressive and predictable nature: the total debt and interest charges decrease steadily over time. However, the main drawback is that as your debt reduces, the deductible interest from your taxable income also decreases. This leads to a higher tax burden. Moreover, you must plan an additional budget to build your private pension savings.

Indirect mortgage amortization

Under an indirect mortgage amortization system, instead of repaying the lender year after year, you make contributions into a private pension plan (pillar 3a), which is usually a life insurance policy pledged for this purpose.

The mortgage debt itself remains constant until the end of the contract. At maturity, the accumulated capital in the pillar 3a account is withdrawn and transferred to the financial institution to repay the second-rank mortgage.

The objective of this approach is threefold:

• To cover the repayment of the second mortgage.
• To build a private capital reserve.
• To provide protection in case of death.

More interests to deduct from taxes

One major difference between direct and indirect mortgage amortization lies in taxation. With indirect amortization, both the debt and the interest burden remain constant throughout the duration of the mortgage.

This is precisely the main advantage of indirect mortgage amortization, since mortgage interest is tax deductible. By keeping the debt unchanged, you can deduct more interest from your taxable income. In other words, the higher and longer your debt, the lower your taxes.

Other advantages of indirect mortgage amortization

When deciding between direct or indirect mortgage amortization, it is essential to take into account other advantages of deferred repayment:

• Tax deductibility of contributions: contributions into pillar 3a are tax deductible, up to the annual limits defined by law.
• Investment returns: the yield generated by pillar 3a savings may exceed the interest you pay to the lender. The better the performance of the investment, the more advantageous the indirect amortization becomes.
• Automatic pension savings: you accumulate a private pension capital without having to allocate additional funds.
• Wealth tax optimisation: the full mortgage debt remains deductible from your taxable assets.

Disadvantages of indirect mortgage amortization

The indirect solution also has drawbacks. Your debt level and your interest burden remain unchanged for the entire duration of the loan. Contributions to pillar 3a are capped (in 2024: CHF 7,056 maximum per year for employed persons affiliated to a pension fund – Credit Suisse).

When you withdraw the pillar 3a assets at maturity, a specific tax is levied. Although this tax is lower than income tax, it still reduces the net return. In addition, since the assets are pledged, it may complicate the termination or refinancing of a mortgage loan.

Direct or indirect mortgage amortization: which option should you choose?

The choice between direct mortgage amortization and indirect mortgage amortization for your second mortgage depends essentially on your personal situation.

For tax reasons, indirect amortization is often more attractive, especially if you cannot make additional contributions to pillar 3a or another savings plan.

Nevertheless, this solution is only appropriate if the overall cost of the loan remains lower than that of direct amortization. This requires a detailed assessment of several factors, including:

• The mortgage interest rate.
• Your marginal tax rate.
• The expected performance of the pillar 3a investment.
  

On the other hand, direct amortization is particularly suitable for homeowners who are burdened by high interest costs and wish to reduce this financial pressure as quickly as possible.

How to decide between direct and indirect mortgage amortization?

If you are uncertain, ask yourself what matters most:

• Would you prefer to maintain a higher level of debt to benefit from greater tax deductions and to build up pension savings?
• Or would you rather reduce your mortgage debt and your interest burden progressively, even if that means fewer fiscal benefits?
  

The answer to these questions will guide you towards the most appropriate solution for your property project in Switzerland.