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When the principle of the lower of cost or market value becomes a pitfall

21.12.2023

Imagine you have found your dream home, the price is right for you and you can raise the necessary 20 percent equity. But then you are promised only 70 percent of the purchase price, not 80 percent. How can that be?

One property – two values

There are several ways to go about valuing a property. The most important of these are the purchase price (or sales value) and the market value (or fair value). 

The purchase price is the actual negotiated price paid by the buyer to the seller.

The market value, on the other hand, is the price that an expert estimates could be obtained for the sale of a property under normal market conditions. It is therefore a pure estimate based on more or less objective criteria.

Lenders always carry out their own market value estimate when granting a mortgage.

Principle of the lower of cost or market value: the lower value is deemed to be the collateral value

Ideally, the sales value and market value should be the same. However, that’s not always the case. But what value does the lender then base the calculation for the financing on?

This is where the principle of the lower of cost or market value comes into play: the lower of the two values is taken as the collateral value – with a corresponding impact on the required capital ratio.

The principle of the lower of cost or market value applies in the following two scenarios:

  1. The market value is higher than the purchase price, which results in a lower equity ratio
  2. The market value is lower than the purchase price, which results in a higher equity ratio

Let’s take a closer look at the principle of the lower of cost or market value scenarios.

The market value is higher than the purchase price

If the lender values your dream property higher than the seller, everything is fine for you: the lender can finance 80 percent of the sales value/purchase price.

Example

  • Sales value, effective purchase price, CHF 1,000,000
  • Market value according to lender’s estimate, CHF 1,100,000
  • Maximum mortgage (80% of sales value CHF 1,000,000), CHF 800,000
  • Minimum equity share (CHF 1,000,000 – CHF 800,000), CHF 200,000

In this example, the minimum equity share is effectively 28 percent.

What is the minimum amount of equity you need?

Use our mortgage calculator to work out the minimum amount of equity you need for the home you want. Or make an appointment for a personal consultation. We will be pleased to advise you in your preferred branch. 

Questions and answers

  • It was introduced in September 2014 by the Swiss Bankers Association (SBA, Swiss Banking). It is part of their self-imposed minimum standards for mortgage lending.

    The link will open in a new window Go to the Swiss Bankers Association

  • It aims to reduce the risk of property bubbles and strengthen the stability of the financial sector.

    Demand for mortgages has risen sharply since the 2008 financial crisis, fuelled by low interest rates. There was a risk of the real estate market overindulging. Too many (and too high, poorly secured) loans increase the risk that many borrowers would suddenly find themselves unable to honour their mortgages and that the financial sector would begin to falter.

    The principle of the lower of cost or market value calms the mortgage market by linking funding to more realistic, prudent valuations, resulting in less risky funding.

  • There are various valuation methods, the most common of which is the hedonic or comparative value method. 

More on the subject

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