Pledging your portfolio to buy your primary residence

Real Estate
41

To put some closure to this thread, here is a an update of our situation:

We’ve made an offer for an apartment but the seller decided to go with someone else (who was offering more money). We’ll stick to renting for the time being. But I’ve learned the following:

  • If you’re pledging your 2nd pillar, you’re still expected to amortize it. Since the interests earned on the second pillar are small (around 1%), the opportunity costs of withdrawing the second pillar are insignificant so you’re probably better off doing just that.

  • Using margin with your broker might be a better solution than pledging your portfolio to your financing institution. It’s most likely cheaper and that way, you’re not at their mercy if something happens.

  • Originally I thought that it would be better to start with a large margin loan (from your broker) in order to have a small 2nd rank mortgage that you have to amortize but I’ve found it a good solution to do the opposite: start with a small margin loan and a large 2nd rank mortgage and “transfer” the debt from the mortgage to the margin loan with the years.
    E.g. Assuming a 1 million property. 650k is 1st rank mortgage, so there are 350k to be covered by your own funds and the 2nd rank mortgage. Since I want as little of my own money as possible invested in real estate, I first thought: use 150k from 2nd and 3rd pillar, and 100k of margin loan so that the 2nd rank mortgage is only 100k and the only money I have to pay back, great! But it’s much cleverer to use 50k of margin loan and 150k of 2nd rank mortgage, because every year, I can increase my margin loan to pay back my 2nd rank mortgage:
    Year 1: 150k 2nd rank ; 50k margin
    Year 2: 140k 2nd rank ; 60k margin
    Year 3: 130k 2nd rank ; 70k margin
    …
    Year 15: 0k 2nd rank ; 200k margin
    That trick has the advantage that it reduces the risk of margin calls (since the sum borrowed is much smaller) in the first year and that, if the portfolio doubles in 10 years (7% per year compounded), I might achieve the ultimate goal of not paying back a single cent because I can put the entirety of the 200k on margin. Since the shift from 2nd rank to margin happens slowly, it gives time to the portfolio to grow and actually safetly support such a high margin loan. If I’m already more or less maxing out my margin loan at the beginning, I can’t reasonably increase it and actually have to pay back the 2nd rank mortgage with my own money.
    And if the portfolio is threatened by a market drop, I can still not increase the margin loan and actually pay back the 2nd rank mortgage for a few years. Note that if you use this strategy with an indirect amortization, you end up paying the interests twice so direct amortization is likely a better option. Note also that accumulating a high level of debt is inherently risky and not advisable for everyone.

  • The mortgage contracts are VERY favorable to the banks. They have so many possibilities to just call the mortgage, it’s scary. I have no doubt that they would use those prerogatives if the rates start to significantly increase. A “fixed” mortgage doesn’t seem to be very fixed in this country (see my other thread on that topic).

Thanks everyone for the discussion, it has certainly been very instructive for me!

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42

No bank that cares for its reputation would just cancel a fixed rate mortgage. I think this fear is irrational.

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43

If they’re not gonna do it, why are there provisions for that in the contract? I mean if they are for sure NEVER going to do that, under any circumstances, why won’t they just delete that paragraph?
When I want to refinance the contract because the rates have decreased, I have to pay them a penalty. Why don’t they have to pay me a penalty if they want to cancel the mortgage?

44

Thanks for this post, very interesting. However, I would be concerned by the interest rates of your broker. To what are they based on?

Also, would you mind explaining that part:

Note that if you use this strategy with an indirect amortization, you end up paying the interests twice so direct amortization is likely a better option.

Thanks in advance.

45

The rate offered by Interactive Brokers in CHF is 1.5% for amounts between 0 and 100k. It’s 1% between 100k and 1 million (I think). It is based on the rate of the central bank plus a margin (basically 0 + 1.5, because they won’t transfer the negative rate).

Indirect amortization means that you only pay back the principal at the end of the contract (as opposed to direct amortization in which you pay back as you go along). Since you’re only paying back the principal at the end, you are charged for interests for the whole sum and for the whole duration of the loan.
For instance, if you borrow 100k at 1% for 10 years with indirect amortization, you pay 100k*1%*10 = 10k of interest. Add 100k of principal: 110k. Which means that you pay 11k per year over 10 years. Note that although you’re only paying back the money at the end of the contract, you’re still wiring 11k a year to a locked account.

If you choose indirect amortization and choose to “transfer” the 11k to your margin, you are effectively paying interest twice because you are increasing your margin loan (and therefore your interest payments) while still paying interest on that money on the mortgage since technically you haven’t paid that money back yet. Does that make sense?

46

I’m afraid that banks are/were already doing worse things… Look for example at some recent examples, like this article: https://www.swissinfo.ch/eng/zurich-brunaupark-credit-suisse/45308004. Then, regarding CS, there was also famous spying scandal, even with some death in the background.

I was not aware the mortgage contracts are, first of all, so asymmetric (e.g. penalties only for you) and secondly, that fixed mortgage is fixed, only until some “nice” guys decide that it should be not.

1 Like
47

Thanks a lot for the explanation. Also, by using a large margin for a long time with your broker, don’t you think that you might be classified as a professionnal trader?

48

If the taxed earnings (dividends) are higher than the paid interests pro rata, you don’t violate this criteria. Just Make sure you don’t violate the 4 other criterias.

49

Exactly. In addition I would argue that the “spirit of this criteria” is that using borrowed money (margin) to invest in the stock market, among other things, classifies you as a professional trader. By using the borrowed money to pay back the mortgage, I’m not investing that money in the stock market. So I would say that, even if you paid more interest than the dividends you receive, you could still make a case that you shouldn’t be classified as a professional trader.

But let’s be honest: unless you invest exclusively in growth tech companies, biotech, and Berkshire Hathaway, it’s pretty difficult to violate that criteria: with interests at 1.5% and 50% of the value of your portfolio on margin (you borrow 50k for each 100k invested - more puts you at a very real risk of a margin call), it means that as long as you get more than 0.75% dividend on your invested portfolio, you don’t violate the criteria.

50

That sounds really low. You’ll get a margin call when the market drops 34%.

51

Well… yes. That’s why I say it’s the maximum leverage you should consider. If you borrow less, the “dividends > interest paid” criteria is even easier to fulfill.

My point is that if you’re reasonably leveraged (less than 50k borrowed for each 100k invested) and if your portfolio offers reasonable dividends (>0.75%), you don’t have to worry about violating the “dividends > interest paid” criteria and be classified as a professional trader.

52

No it is proportional. If you borrow only 50k you are still supposed to have more than 1,5% If you borrow at that rate.

53

Really interesting thread. My bed that I missed that so far…

In my experience and those of my friends who also bought a house, usually before you buy it, you have +1’000 questions and you balance so many risk factors on a huge excel sheet. But once you bought your house, things are really going much simpler than you think.

Not sure about that. Who is expecting that? The bank don’t care. The 2nd pillar company either as they will just reduce your final rent calculation. The only thing is, that when you take 2nd pillar money, your PK will pay out less in case of sickness or death. But many company this gap is automatically insured. So the only difference is that you put 2nd pillar money in good use to improve you quality of life. Instead letting it rot with 1% for many years.

54

If you’re withdrawing your second pillar, yes, you don’t have to pay it back to your 2nd pillar company. You can, but you don’t have to.

But if you’re pledging it (“pfänden” in German, “mettre en gage” in French) you’re expected to amortize it. By pledging your second pillar, you’re increasing the 2nd rank mortgage (that you have to amortize) and not the 1st rank mortgage (that you don’t have to amortize). At least, that’s what the MoneyPark advisor told me.

That depends on your retirement institution. Mine is quite generous and does not reduce the benefits (or very slightly) in case of early withdrawals. Same for my wife’s. But we are working in the public sector.

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55

Do know that most here a kinda against buying a house/flat, but I am super pro for buying an own property. It really gives you much back in a day by day bases, which can’t be put on numbers on an excel sheet.

Challenge are the current high prices and finding an object with covers your needs (and also bit your dreams).

3 Likes
56

You can amortize very slowly, using all the years you have before retirement…
Also you can use indirect amortization in a 3a with funds, this is what swisslife proposes.

57

as @OogieBoogie says, most mustachians seem to be rather against real estate, so let me share my experience of a real estate enthusiastic with you - feel free to ask questions and to play the devil’s advocate!
we are a family of 4, our 2 kids go to private school as we both work 100%.
We live in the flat we bought and we also have investment real-estate in Switzerland.

My first advice would be to buy at a good price compared to the market. I see too many people buying oversized and/or expensive flats, having to pledge their 2nd and 3rd pilar (including couples/families with a single income…), which I do not recommend unless it is an investment strategy and you have a solid emergency fund. We found our real estates on Homegate, with no network, just patience. And we literally jumped on the good deals we found. And most important: location, location, location.

In our situation it was always MUCH cheaper to live in the flats we bought vs renting, between -20% and -40% cheaper, including all costs (Nebenkosten, Erneuerungsfond). which means that each month we saved between 500 and 1000 CHF, which we obviously re-invested elsewhere. Taxwise the “Eigenmietwert” is more or less compensated by the interest rates + Nebenkosten deductions.

We chose not to amortize more than necessary (except the 20% own funds + 16% to amortize within 15 years + eventually some mandatory amortization by the bank) in order to make invest this money elsewhere.

rental income : yield around 3 to 6% after income tax.

if we would sell our properties now, we would have a very nice capital gain - obviously we do not know what will happen in the future (like stocks…)

I often hear about the real estate bubble and market crash. I believe that, such as ETF’s/stocks, you do not lose money unless you sell your assets. Unless there is a really big crash, there will always be people who need to rent flats

Now to the drawbacks:
20% cash + keep solid emergency fund
real estate is not liquid
investment real estate: if you manage the rentals yourself, you have to be available very quickly (machine breakdown, complaints from neighbours…)
interest rates: always have a solid emergency fund, shall the interest rates double or more. I follow the interest rates evolution so that we are prepared to amortize a chunk or sell if needed
attention to extra maintenance costs (which could sometimes be financed with the Erneuerungsfond)
do not underestimate harmful neighbours :confused: (jealousy, greed or even theft, yeah…)

Success factors:
we negotiated our interest rates by questioning several banks at the same time, and letting them know that they are in competition
as soon as we have the intention to buy we have a meeting with our bank to validate our financing capabilities (“Tragbarkeitsberechnung”), so that we are ready to jump immediately on an opportunity

looking forward to your reactions!

Edit: we started to invest on the markets only 1-2 years ago, as we were not confident/well-educated enough to start investing in stocks and ETF’s. If we would have invested the 20% on the market instead of real-estate, maybe we would have had a better yield now. We have no regret, as investing on the markets was not an option at that time.

8 Likes
58

Thanks for the interesting post about your personal real estate experience.

Would you mind to share your calculation of your rental yield? 3%-6% is a great yield!

59

sure, one example here
monthly rental 2600 (excluding Nebenkosten to be borne by the tenant)
minus 500 for Nebenkosten (borne by the owner)
minus 1000 for mortgage
-> ca. 1100 before income tax
I calculated with a high marginal tax rate of 40% (not fully sure), so ca. 700 net after income tax.
the return is calculated on the 20% initial deposit + the 2nd rank we already amortized ->
(700*12)/243k deposit = 3.5% net return

it is good indeed, but we shall not forget that such returns are due to the fact that in Switzerland there is no obligation to fully amortize a property. If we would amortize, we would probably not have a positive cash-flow. Which definitely means that properties are indeed overpriced in Switzerland (except when thinking about current property prices in cities like London or Paris…)

any thoughts? experiences ?

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60

Are you sure about that, ie did you confirm with the authorities? That’s not how I would interpret the “pro-rata” in the original official document (Kreisschreiben 36, 2012). Instead I would interpret it in the following way: take the dividend (Wertschrift) of your respective investment (total holdings) purchased and compare it against the pro rata margin interest paid. Example: purchase single ETF on margin -> the dividend earned on the entirety of holdings in this ETF (including both those purchased on margin and those purchased with own capital) should exceed the margin interest.