Extend or amortize: why do you even have the choice?

A mortgage – whether it is a fixed-rate mortgage or a Saron mortgage – is usually divided into a first and a second mortgage.  The first mortgage may amount to a maximum of two thirds of the collateral value of the house. If buyers need more external funds, this is covered by the second mortgage. The total mortgage may not exceed 80 percent of the collateral value.

An amortization obligation exists only for the second mortgage; this must usually be paid off within 15 years or upon retirement at the latest.  Amortization of the first mortgage is voluntary. However, you are not free to choose the timing of the amortization. With fixed-rate mortgages, it is generally possible free of charge only at the end of the term, and with Saron mortgages, at the end of the agreed framework term. 

What factors play a role?

The following factors play a role in the decision to make a (partial) repayment:

• Current interest rates
• Taxes
• Individual investment behaviour 
• Individual liquidity requirements
• Value development of the property/loan-to-value ratio

Let’s take a closer look at these factors.

When you amortize, you save on (high) interest rates

It’s obvious: if current interest rates are very high, extending the entire fixed-rate mortgage is not very attractive. In this case, it may be worthwhile to (partially) repay the debt in order to save on interest rates. But whether this really makes sense depends on your situation with regard to the other factors.

When you extend, you save on taxes

Saving on interest rates is just one side of amortization. The downside is that you can deduct less to no interest from your income. This increases your tax burden. Conversely, this means that if you extend the mortgage unchanged, you can continue to save on taxes. So the question is:

Which would be greater: the interest savings from amortization or the tax savings from continuing with the same mortgage amount?

However, it is uncertain how long this tax advantage will continue to exist. For many years, there have been repeated political initiatives aimed at overturning the taxation of the rental value. The current law means that homeowners must pay tax on the rental value of their property as income and can deduct the mortgage interest in return. Were the law to be repealed one day, the benefits of amortization would have to be recalculated.

If you like to invest in shares, you should extend

If are potentially able to amortize, this means that you have a large amount of liquid funds at your disposal. This is money that you could invest differently – in shares, for example. The question you need to ask yourself is:

Which would be greater – the interest savings from amortization or the return on an investment?

To get a reliable answer to this question, we need to compare the net interest rate for the mortgage (after tax) with the net return on investment (also after tax). The latter is of course unpredictable in the case of market price-dependent investments such as shares. In the example below, we expect a long-term return of 2.5 percent. 

Amortize or invest

If you want to remain financially flexible, you should extend without repayment

When you amortize, you put your money into the property. This does not mean it is gone, but it is no longer available for other projects and necessities. For example, if you are planning a renovation, you should use the money for this rather than to pay off the mortgage debt.

Especially if you are about to retire or have already retired, you should not tie up all your liquid assets in the property. Otherwise, you will not be flexible enough to react to new life situations and needs. It is usually not easy to get a new mortgage or to increase an existing mortgage, especially in old age.

If the property loses value, you may be obliged to amortize

A final point that could be relevant for your decision is the loan-to-value ratio. In principle, a mortgage may not exceed 80 percent of the collateral value.

If the value of a property falls, the loan-to-value ratio increases while the loan amount remains the same. Generally, a mortgage may not exceed 80 percent of the collateral value, provided this is also affordable for the borrower. If the value of a property falls, the loan-to-value ratio increases while the loan amount remains the same. If the loan-to-value ratio rises above the loan-to-value limit set by the lender, the lender could demand amortization in order to reduce the loan-to-value ratio.

If property prices fall, new amortization obligations may arise, even though the loan-to-value ratio is low. This is the case, for example, if the loan-to-value ratio may apply only within the first mortgage and the loan-to-value limit of the first mortgage is exceeded due to the reduced property value (e.g. retired borrowers with a loan-to-value limit maximum of the first mortgage).

Conclusion: consider your options carefully and seek advice

There are many factors to consider when deciding whether to renew or amortize. What are the current interest rates? What does your tax bill look like? How much cash do you have at your disposal? What type of investor are you? Do you have any pension gaps that need to be closed? How much liquidity do you need? What does your financial future look like – especially after retirement? 

In many cases, the arguments in favour of renewal outweigh the arguments against it, but there is no one-size-fits-all solution. Seek support from PostFinance for your individual investment plan, and let our experts advise you. 

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