How do reverse mortgages work?

Author: Bernhard Bircher-Suits, FundCom AG

Hanspeter Meierhans (56, name changed) lives with his family in an old, detached property in Zurich. This has a mortgage of around CHF 1 million with his principal bank. For tax reasons, Hanspeter has so far refrained from significantly reducing his mortgage. He says: “The loan interest that I pay to my bank can be deducted from my taxable income year after year.” As a result, the accountant has so far avoided repaying his home loan further, or “amortising” it, using savings or his pillar 3a credit.

It’s important to understand that Hanspeter has what is known as a “first-ranking” mortgage. This means that he has no obligation towards the bank to pay off more of the house loan by the time he retires. In Switzerland, lenders generally grant an initial mortgage of up to 65% of the property’s value. 

Fixed housing costs as no more than one third of your income

From the bank’s perspective, one thing is clear: Hanspeter Meierhans can leave his first mortgage in situ as long as he likes – even for the rest of his life – as long as he always pays the interest on time and his pension income is sufficient to cover this.

Anyone, whether in work or retired, who takes out a mortgage must be able to prove to their bank at any time that they can afford it on a financial level. The imputed fixed costs associated with owning your own home (interest, amortisation, ancillary costs) should not exceed a third of your gross income. If this ratio of fixed costs to income is out of balance, affordability is no longer guaranteed. 

Banks take a closer look at customers aged 55 and over with a second mortgage

Banks’ contractual conditions stipulate that a borrower’s credit file must be re-checked in instances of “events relevant to their creditworthiness”. Some banks contact their customers holding second mortgages as early as the age of 55 to ask about their pensions and other income after retirement.

By law, mortgage borrowers only need to amortise their second mortgage within 15 years or by the time that they reach retirement age. 

Higher amortisation payments are a risk in cases with large income gaps

If you are at risk of a large income gap when you retire, you may have to make higher repayments. Florian Schubiger from the mortgage brokerage platform www.hypotheke.ch says: “If you remain in work for longer, you must nevertheless have made the relevant repayments by the age of 65 at the latest: exceptions are only made in rare cases. It is important that your mortgage is affordable in old age – even if loan interest rates rise.”

Peter Burri Follath, Head of Communications at Zurich’s Pro Senectute Switzerland, adds: “It can make sense to build up additional reserves or make extra repayments to minimise your burden in retirement.”

It can be difficult to top up your mortgage from the age of 50 onwards

Once you’ve turned 50, it becomes more difficult to get a bank to top up your mortgage for use on renovations, as your disposable income is decreasing. Many banks carry out in-depth financial affordability checks upon a person’s retirement, if not before, which can lead to forced sales.

Often, people use a large swathe of their pension fund assets to repay their mortgage, which reduces their pension and ability to take on credit. The rise in property prices has given pensioners a certain amount of protection, but this could quickly vanish if prices fall.

Pro Senectute and HEV recommend reviewing your situation from the age of 55 onwards

Pro Senectute Switzerland recommends that people over the age of 55 should carefully review their mortgage situation and adjust it if necessary. Pro Senectute Switzerland spokesperson Peter Burri Follath says: “It is advisable to think about financial affordability after retirement at an early stage and to make sure that you can still cover your monthly expenses with your reduced pension income.”

As a rule of thumb, the tighter your budget in old age, the more important it is to plan carefully – and to do so ahead of time. James H. Kuhn is head of the mortgage advisory service HEV-Hypothek. He has the following advice: “You shouldn’t rely on what your bank says. It’s better to get holistic advice so that the money is put in the right place and withdrawn at the right time, and so you don’t end up under pressure to sell your property. 55 isn’t too early to get started with this – if you’re older, I’d get cracking right away.”

Check out the alternative: reverse mortgages

Are your savings already tied up in your property? And will your future pension income hardly be enough to finance your day-to-day life and cover any unexpected events? A “reverse mortgage” can help.

This works in the opposite way to a normal home loan: you get money instead of paying off the loan. A reverse mortgage is a loan agreement under which your property serves as collateral. For example, the mortgage can be increased to a maximum of 50% of the property’s value and taken out as a fixed-rate loan over a period of 5 to 15 years. The interest for the entire term is deducted in advance, and you can use the remaining amount at your discretion to enhance your (pension) income or make the necessary investments in your home, for instance.

At the end of the term, you can sell the property, pass it down to your descendants or extend the mortgage, as long as the maximum loan-to-value ratio is not exceeded. Please note that a reverse mortgage is only a suitable solution for older people who have mostly paid off their mortgage on their home. 

Several Swiss banks offer reverse mortgages

Not all Swiss banks offer reverse mortgage products, but providers like VZ Vermögenszentrum, Sparkasse Schwyz, Bank Sparhafen Zürich and Thurgauer Kantonalbank offer this service.

At Thurgauer Kantonalbank, individuals or couples over the age of 60 who own a home that has already been paid off in full or in large part can apply for a reverse mortgage. The minimum amount is CHF 100,000. Another requirement: the property must be in good condition. The increased sum, less the interest for the agreed term, is paid either as a total amount, in two instalments or as a monthly annuity.

Whichever bank you choose, a reverse mortgage always has pros and cons:

Benefits of a reverse mortgage

• Additional liquidity: with a reverse mortgage, homeowners can receive additional money to top up their pension without having to sell their property.

• Flexibility: the payment is made as a one-off sum or as a regular annuity. Models such as partial sale offer flexibility and make it possible to liquidate only part of the property’s value.

• Continue to live in your own home: you have the option of continuing to live in the environment you’re familiar with. This is particularly valuable in old age.

• No monthly repayments: unlike normal mortgages, you don’t have to make monthly repayments.

• Cost coverage: the reverse mortgage can be used for unexpected expenses such as care costs or renovations.

Drawbacks of a reverse mortgage

• High interest costs: the interest for the entire term of the mortgage must be paid in advance, which reduces the amount paid out.

• Few providers: very few banks in Switzerland offer reverse mortgages, which limits the range of options available.

• Less inheritance: the value of the home that can be passed on to the heirs decreases as the mortgage has been increased.

• Loan-to-value limit: as a rule, the mortgage may not exceed 50% of the market value, which limits the maximum loan amount available.

• Fixed interest rate: the interest rate offered is usually the official “shop window” rate. Banks leave little room for negotiation.

• Loss of value: selling part or all of your property through your principal bank can be less profitable than selling it on the open market.