I’m writing this post both to structure my own thinking and to gather comments, opinions, and experiences.
TL;DR: I am calculating the financial consequences of pledging our portfolio of stocks (instead of selling it) to buy our primary residence instead of renting.
Meet me 30M and my SO 31F. We are married, no kids although that may change, living in Kanton Aargau for the past 7 years in a small but cozy appartment close to a train station, paying about 1340 CHF rent (1460 with Nebenkosten). We don’t have a car and would like to keep it that way :). We are both engineers in the public sector earning a combined gross income of about 210k CHF per year. We save about 75k a year (terrible saving rate by moustachian standards…). Our net worth comprises of:
- 58k in various 3rd pillars at banking institutions (51k cash earning 0 interest or close, 7k at the LKB in a 50/50 share/bond fund following the advice of this forum)
- 34k in Fundsmith
- 210k in stocks and index funds (mainly BRK.B though)
- about 80k in our 2nd pillars (relevant because we are talking real estate)
My personal goal is FI but not quite sure about complete RE. My wife would like to keep working and have a career.
I’ve always assumed that we would keep renting because we have no interest in “owning” a place and because of the huge opportunity cost that the 20% investment in the property produces. Let’s assume a 800k property. That’s 160k coming from our own pockets. 200k if you count the notary fees. I always knew you could use the 2nd and 3rd pillars but in my mind (and in reality) what we had was too little for even consider it.
What I’ve discovered might not be news to you but it certainly was for me: you may not have to sell your portfolio of stocks, you can just pledge it (in french: Link). And even better: you apparently don’t have to amortize your loan in that case because the totality of the debt is of first rank (Link). Of course the bank applies a discount to your portfolio so it doesn’t provide you with a 100% buying power but 50% seems to be the typical lower limit.
What this offers is the possibility to live in your own home without having to pay a penny of principal. Just pay the interests.
Let’s go back to our example: a 800k property (which would be nicer than what we have right now). We pledge both our 2nd pillars (80k) and a fraction of our portfolio (160k of our portfolio, to get a discounted value of 80k). We then use our 3a to pay the notary fees (50k). With this, we get a mortgage for the full value of the property (800k) that we don’t have to pay back. With current interest rates (let’s be conservative and select fixed rate for 10 years around 1.2% from MigrosBank, although I’ve seen better rates), that makes 800k*0.012 = 9.6k per year or 800 CHF a month.
Significant savings compared to the 1340 CHF we pay now. And that’s if we don’t optimize the rate with different term periods (for instance 50% with 10 years term (1.19%) and 50% with 5 years term (0.92%) would make my monthly payments about 700 CHF). Investing the 500 CHF difference per month at a conservative 5% would give us an extra 77k after 10 years and about 400k after 30 years.
Now this strategy would make us very vulnerable to an increase of the interest rate. Enter the Bad Scenarios.
Let’s assume that after 10 years the interest rates double to 2.4% (Bad Scenario 1). That would make our monthly payments 1600 CHF. More than what we pay now but bearable. But we could use the 77k we saved on rent and invested to reduce our mortgage by about 10% (77/800 = 9.6%) and only pay 1446 CHF a month. Just a 100 CHF more than what we pay now, for a bigger and nicer place. We still have our portfolio and our 2nd pillars. We survive BS1 with a smile. FIRE is still very much an option.
Now, what if the interest rate reaches 5% (BS2). That would make our monthly payment a whooping 3333 CHF. If we reduce our mortgage by the 77k we saved, we are left with a monthly payment of about 3000 CHF. Crazy amount but yet still bearable. At that point, we have two sources of capital to invest:
- the value of our untouched portfolio after 10 years (more than 650k if we just contribute 2k a month (we do 5k now but we both work full time and no kids, which may change) for the next 10 years at 5% ; about 350k if we stop contributing today and let it grow at 5%), and
- the value of our 2nd pillar that will keep growing (about 2k a month at 0% => 318k after 10 years).
Both on top of the 77k we would be saving on rent over the last 10 years. We would probably sell 400k worth of shares and reduce our mortgage by 50% and make our monthly payments 1667 CHF. Still more than what we pay now, but not a killer. Lower portfolio but still decent value and two full 2nd pillars. We survive BS2. Most likely no early FIRE but 55 is still in the charts.
But that’s not the worst case scenario. The worst case scenario is if the stock market crashes considerably, let’s assume 50% of current value in 10 years. That’s -7% a year every year for the next 10 years. Let’s combine that with interest rates at 5% after 10 years to create the monster BS3. With these rates the value of our portfolio would barely increase even with 2k monthly contributions to 276k. Let’s assume -7% a year for the 2nd pillar too, which would make even the swiss take the street btw., we get to 211k with 2k monthly contributions. Because the interest rate is 5%, we have to pay 3333 CHF a month.
At this point no bank would refinance a 100% first rank mortgage, so we would have to pay potentially 33% of the value of the property or 264k. That pretty much the entirety of our portfolio. We are left with a traditional 1st rank mortgage for 67% of the value of our 800k property at 5% interest, or 2233 CHF a month. Bad? Yes. We have no investment left and we pay about 1k CHF a month more than a traditional rent. But is it terrible? No. Instead of investing 2k a month as I assumed for the past 10 years, we would only invest 1k a month. And we still have our fully funded 2nd pillars. Conclusion: we also survive BS3. No FIRE but a comfortable traditional retirement.
Now there is a BS4 in which the housing market crashes as well (very likely with interest rates at 5%). At that point, the bank may “margin call” us. This would most likely happen during the 10 year mortgage rather than at the end of it. If the housing market drops suddenly by 20%, we would have to give up some or all of the portfolio that we pledged. Maybe some of our 2nd pillar too. This would be really bad. But at the end of it, assuming the worst, we would be two 41 year old engineers, with no investment, no retirement money and a “rent” of about 20-30% of our income. But we wouldn’t be bankrupt. We would most likely still have decent jobs. And still have 25 years to recover until actual retirement. We would also survive BS4. No FIRE but a decent retirement (maybe not in Switzerland though…).
Btw, I haven’t considered the impact of BS1, 2, 3 and 4 on renting, but it is likely that the costs would increase as well. According to Comparis, a 1337 CHF rent at 1.5% reference interest rate jumps to 1900 CHF when this rate reaches 5%. So it’s not like renting would be a safe haven either.
What I also didn’t account for are the tax consequences. I thought that I would be winning some CHF here as well, by having a large mortgage, but it seems that the eigenmietwert more than compensates the deduction, even by using generous estimates (Eigenmietwert=2% of the price of the property, maintenance charges = 30% of the Eigenmietwert) (calculator). So I should investigate a bit further that aspect…
I also didn’t account for maintenance costs. I know they can be pretty large and very dependent on the property you buy. That’s honestly the main reason why despite all this I’m still sceptical about the whole thing… One of my colleagues had to put 20k on the table because her garage had water infiltration… that’s 3.5 years of rent savings in our case.
This strategy also has the drawback of correlating everything to the performance of the stock market. Whereas one of the benefit of “traditional” real estate investing is to add diversification (even if your portfolio collapses, at least you have your home).
I implicitly accounted for inflation with the conservative estimates. In case of a mortgage (negative investing), it plays in our favors, as our salaries increase, but not the debt.
I know this was a lot of text so if you’ve read until here, congratulations! What do you guys think? Am I missing something? Do you think it’s worth it just to save 500 CHF a month and to have 800k appreciate more or less at the rate of inflation (most likely scenario for real estate at this point, 1% a year).