Pay back the mortgage, or invest the money instead?


#1

Hi guys,

First post here, right when I am about to buy a house and therefore choose a mortgage. Thanks for existing! :slight_smile:

Here in CH, most people actually do not buy real estate, and the ones who do never pay it back completely. I come from another culture, where debt is best repaid as fast as possible.

People here normally tell me that they do not pay back the mortgage because of the tax benefits: the debt pushes down your taxable wealth and the interests can be deducted from your income. This is something I find hard to understand, because the wealth tax is really low, and the tax deduction you get on the interests is obviously just a fraction of the actual interests paid to the bank. If anyone sees where I am wrong here, I’d like to hear from you.

What does make a difference (especially now that mortgage rates are so low) is to not pay back (or pay back not as fast as possible) and invest the money instead, hoping to reap some 5-6% when you “borrowed” the capital from the bank at the current interest rates of about 1.1% for 10 years.

So, what would you do if you were me? Pay back? Not? How much?

Right now I am thinking of splitting the mortgage in several chunks, each expiring some 2-3 years before the next, such that in the meantime (if I keep working and everything goes as planned) I can save up (part of) the sum and pay it back at the end of the mortgage. I am calculating that in this way I would still be able to save a decent amount to invest in the stock market.

I’d love to hear your stories/opinions!

G


#2

Hey Giff,
i never calculated numbers, but the reasoning you put down here seems legit to me. One more aspect you should not forget: inhabiting your own house costs you taxes according what income tax you’d pay if you rented it out (=special swiss thing). this definately has something to do with people not fully paying back their mortages.

in the mean time, there is tons of threads in the MMM forum (just browse the first few pages) about the pay-back-or invest-instead topic.

basically, by investing instead of paying back, you apply leverage or margin. it ads the risk of losing more than you own, for a chance to outperform.

no solid advice beyond this from me, sorry :slight_smile:


#3

What you have to consider is that you cannot pay back the mortgage before your term ends. We have for our situation the following plan (at the moment):

Bought house for 545’000 CHF in 2016 with a 10-year mortgage at 1.24%. We have to pay back amortisation which is yearly 5000 CHF. We do this directly and pay the interest all three months. At the same time we max out our third pillars and will use them in 10 years to pay back some more of the mortgage because we want to reduce work then and as your income must be 3 times higher than the calculated mortgage payments (calculated with 5% and 1% additional costs and 1% amortization). Otherwise acceptability of risks wouldn’t apply anymore for us and we wouldn’t get a mortgage again.

Imputed rent makes that you have to pay more taxes. It is not that much for us as I know, but I haven’t calculated it. If you pay it back then you don’t have the mortgage payment and only more taxes. With the low interest rates at the moment you pay usually more in taxes because your interest is lower than the imputed rent. Usually it would be "imputed rent - interest payments = +/- 0 effect on taxes. But if interes payments are higher you would pay more interest and less in taxes so I think it doesn’t really matter in every case and has to be calculated for your own situation.

We took the long mortgage because we wanted to be able to plan with a fixed interest rate. If the interest rate in 10 years will be very high we will pay back more, if it is lower we will calculate what is the optimum for us.


#4

Thanks for the link to the other forum which I did not know :). I did not mention the eigenmietwert because one has to pay that anyway, independently of the choices I am looking at.


#5

Yes, most banks will not allow you to pay back during the mortgage, but what you can do normally is to split the mortgage in tranches and pay back (if you can) at the end of each tranche. This has a possible drawback though: if you cannot pay back when one tranche expires, no other bank will give you a mortgage and you are stuck with the same bank, which will then have no need to give you a good rate.

The eigenmietwert is going to be there no matter what. AFAIU, the difference between paying back and keeping the mortgage is whether you give money to the bank or to the community through taxes. I am not sure why people prefer to give to the banks?


#6

Probably because a lot of people have really high mortgages and cannot pay back the whole mortgage. Most houses or apartments cost a lot.


#7

That could be a reason, but if you ask them, they will say that they do not pay back for tax advantages…


#8

That’s because the banks will tell you that very often. When I asked for our mortgage he also always told me how I could save on taxes. With not paying back, with an indirect amortisation. I told him I wanted to do it directly and save at the same time in the pillar 3a. I think most people will believe what the banking human tells them.


#9

Not all debt is equally bad. If you can reasonably reinvest the capital at a much better rate of return than its cost, then it’s a good debt.

Wrong. People don’t pay back because of extremely low rates. It’s one of the cheapest sources of money around here. Should the rates jump to 5-10%, you’ll quickly see people lining up to pay it all back.

And the house value pushes it up, so it all balances out. Mortgage and repayment of it has no effect on your taxable wealth. The act of buying the house alone however does, because for tax purposes the house is often valued a lot lower than the price you’ve actually paid for it.

This deduction doesn’t make the mortgage free, it’s still always a cost. It’s better to think of it as a discount on mortgage rate equal to your marginal income tax rate.

[quote=“Giff, post:1, topic:318”]Right now I am thinking of splitting the mortgage in several chunks, each expiring some 2-3 years before the next, such that in the meantime (if I keep working and everything goes as planned) I can save up (part of) the sum and pay it back at the end of the mortgage. I am calculating that in this way I would still be able to save a decent amount to invest in the stock market.
[/quote]
Don’t split up mortgages, this is a really bad idea, it locks you down to your current bank - you’ll be practically forced to pay back each tranche or refinance it at whatever rate your bank dictates. Don’t expect to be able to partially refinance it at another bank, most banks won’t do that.


#10

[quote=“Erma, post:8, topic:318, full:true”]That’s because the banks will tell you that very often. When I asked for our mortgage he also always told me how I could save on taxes. With not paying back, with an indirect amortisation. I told him I wanted to do it directly and save at the same time in the pillar 3a. I think most people will believe what the banking human tells them.
[/quote]
Usually you should take banks’ advice with a grain of salt. But this is actually a very good advice, indirect amortization is much better than direct - it allows you keeping loaning more money at ultra low rates and get the tax benefits.

With direct amortization all you’ll get is a savings of 1% or whatever your mortgage rate is - is this a good use of money to you?


#11

For our situation it is a good use as we don’t know when we will reduce working hours so it is more save to pay it back and save at the same time in a pillar 3a and use this to pay back the mortgage later. We will have to pay back because of he 33% rule and our unwillingness to work our whole life. So for peace of mind it is the best solution for us.


#12

If you go for direct amortization, you’re paying back the mortgage every year, not later. And getting a measly 1.24% return on capital in the form of mortgage interest savings.

With indirect amortization, your yearly repaying obligation is waived away so long as you pay into pillar 3a. If you would pay into pillar 3a regardless and want to repay the mortgage as late as possible, it doesn’t make sense to not go for indirect amortization


#13

I can live with that. I’m still investing the rest of the money and look at it as some savings account.


#14

Except that they cannot pay it back when they want. What if, at the end of your 10 years mortgage, you want to pay it back but at that moment the interests have gone up and your investments are losing money so that you don’t want to sell?

My (current) idea is to actually pay back the tranches. Even if for some reason I would not be able to pay back the whole tranche, the fact that they are not so large (e.g., 100k) will mean that the unfavourable rate that they will offer then won’t be too much of an issue.


#15

Am I wrong, or amortising into the 3rd pillar will not decrease your debt?


#16

If you have a fixed mortgage, your rate is fixed until the term’s up and then you have a choice - pay it all back or take the current rate. If rates will have skyrocketed, most people presumably would prefer to pay up rather than continue borrowing.

Why? At current rates it’s far better to borrow and repay as late as possible. Or does a savings account that pays 1.1% interest sounds like a good idea to you?

Exactly, your debt stays the same - you continue borrowing same amount of mortgage money at these ultra low rates. And at the same you reap huge tax benefits for paying into 3a and some modest interest or index fund returns over your 3a conto. Whereas if you amortize directly, it’s just like putting money into a f’ing 1.1% savings account (or even less, considering that mortgage costs you less than that due to tax deduction)

Also note that banks here are highly unwilling to increase the mortgage later. For risk management purposes, they all want to see it decrease over time to 65%, not increase. They’ll approve an increase usually only for renovations. Delaying the paying back for as late as possible, such as with indirect amortization, is the next best possible thing to increasing the mortgage.


#17

But pay up with what? Perhaps your stocks are down that year and you don’t want to sell at a loss?

Well, you see it as a savings account. I see it as my home, something which I would like to own 100% myself and not 20% myself and 80% the bank.

Again, you are probably right from a strictly financial point of you and we’d be better off borrowing at 1% and reinvesting in the stock market rather than paying back the house. But the other option is to eventually own the place and forget about it.


#18

It’s up to you how you’ll manage that risk. Yes, if you’re highly levered up and interest rates skyrocket, it’s not gonna be easy at all. House prices will likely drop due to high interest rates, so even if you sell the house, you can still end up owing money to the bank - mortgages are full recourse here, bank will go after all your other assets. This is a basic risk with any leveraged investment

The banks manage the risk for themselves by instituting draconian requirements on borrowers: they use 5% interest for affordability calculations - your income must be high enough so that if worst comes to worst, you’ll still be able to pay 5% mortgage interest, 1% NK and have 2/3 of income left for other things. And you must repay some 1% or so every year to get the mortgage down to 65%. This rules out most of risky borrowers.

At current interest rates and level of housing prices in Switzerland, this is a highly inefficient use of money and a big luxury.

But in some other countries I could name where land and houses cost a tiny fraction of what they cost here and mortgages rates are in double digits, situation of course will be different,


#19

As other people pointed out, this is leverage. Therefore, you can do it, but only if you examine very carefully the implications.
I would suggest trying to imagine the absolute worst case scenario, and see if you can stand it.
-I guess that if you invest the money it will be in the stock market. What happens if it goes down 70% in the next two years? The theory says to never sell, but will you be able to it?
-What if at the same time, interest rates go up 5%? How big will be your mortgage then? What about 10%?

Don’t be shy with the assumptions. The goal is to determine the point where it would be Game Over for you, and see how far you are from this point. Then you can decide if it would be wise enough to invest with leverage.

The reason I am saying this is that every time I read a story about a financial failure, the very common point to these stories is leverage. Handle with care then.


#20

Right, and I would feel safest by having a small mortgage :).