Why would an interest increase of 3% jeopardize so many real estate loans?

The vice chairman of the Swiss central bank recently said in a speech that (quote) “between 20 and 30 percent of newly granted mortgages would no longer be sustainable if interest rates rise by 3 percentage points.” See also the link below.

To my understanding, banks calculate with a potential interest rate between 5-6% when granting a mortgage. So why would an increase of 3% be a problem? The only reason that I can think of is this: Mortgages must be reduced to 65% of the real estate price within 15 years, so if interest rates go up and prices go down, people would be in trouble.

Or am I missing something?

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Are those 5% calculated for everyone, or do professional investors receive different conditions? I could imagine that professional investors with a rather large real estate portfolio might be treated differently in terms of potential interest rate.

Plus banks might get more creative with the loans and negative interest rates nowadays. I can’t say for Swiss banks, but I know German banks are doing it already for a while. So yes, while officially they have to consider potential interest rates, there are ways to trick the system. And if the quotes for the quarter are not looking well, managers are also approving mortgages who would not qualify (speaking strictly about Germany in the last two sentences)

Yes, banks calculate that with 5% the costs are not higher than 33% of your income.

Currently, interest rates are very low and make up much less than 33% of people’s income, what makes real estate quite affordable at the moment. However, we also know that these affordability calculations are very tight and 33% or 1/3 of ones income just for housing is actually a very large part of the pie, and that many people buy real estate even though they barely can afford it. People use all their savings, sometimes even their pension funds (2nd pillar & 3a) just for the sake of owning property and literally ruin themselves like that.

We also know that many people live beyond their means, e.g. they have expensive cars, suddenly they have 1-2 or even 3 children which are expensive, maybe pay for a private school for children or their piano or guitar lessons, go on holidays regularly, have expensive hobbies, eat in restaurants quite often, or whatever, so many people don’t have much money left at the end of the month and their savings are very limited. So if now their costs for financing their property significantly increases, it will constitute a big financial problem for many and they can’t afford it anymore even though the bank calculated with 5% but didn’t take into account that the living situation may change.

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I woud also like to understand the SNB’s underlying analysis.

My thoughts:

  1. 3% increase would take us from ~1% mortgage rate today to ~4%. This is virtually at the 5% stress test rate. As the affordability calc is not a precise science, I would assume it is not binary that once we cross 5% people start to get into problems and lower than that everyone is ok. There must be a continuum and issues start before 5%

  2. The stress test assumes no more than 1/3 of income should go on housing cost, this is a rule of thumb and some people may not have 1/3 of income available for housing

  3. People’s situation may have changed since taking out the loan e.g. lost job during Covid

  4. A rate of 4% is a 400% increase in interest costs vs. today, it could lead to house values decreasing and owner’s equity decreasing or negative equity. When renewing loans the banks may ask owners to stump up more equity or increase amortisation. If buyers stretched their finances to make the initial downpayment and perhaps already withdrew their 2 pillar it might be tricky to stump up more equity

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I can confirm that over 50% of my clients wouldn’t be able to pay 3-4% interest per year. It doesn’t matter that banks are calculating with 5% when people are living beyond their means.

~65% of all people above 18 are saving less than 500 CHF per month, most of them basically zero.

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This is a cool insight I got while working in Banking (in Portugal that is, no experience in Switzerland). Almost everyone was living pay check to pay check (income didn’t matter) and around 10-15% were going negative every single month, paying 15% interest on the borrowed about

I was discussing this with a fellow mustachian friend, how do people spent so much in Switzerland?
Your spending just continues to grow as your income grows?

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I have only one word to say: Damn!

Lifestyle inflation.

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Yes that’s a scary insight.

We come back to the same conclusion: so long as interest rates stay low the housing market will be ok (separate thread on inflation)

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The reasonable thing would be to think “Cool, I’m paying 1% instead of 5% interest, I should save/invest those 4%”. But usually it ends up being “Cool, interest rates are so low, now I can lease a 2nd Mercedes C-class”.

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Reading this I realize that we here in the forum are even more a minority than I thought… :confused:

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Damn, I can’t find the recent statistic I saw a couple of weeks ago. But this should show it too:

Not only do 40% not save anything at all, they even have a negative saving rate lol.

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I wouldn’t say “lol” when referring to a negative savings rate…

  1. Quintil has CHF 3’407.- total household income, 2. Quintil CHF 4’592.- That is probably enough for one person, but imagine two people or even a family with kids.
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Saving isn’t about how much you are earning, rather how much you are spending. Making kids = spending more money. So if you have a negative savings rate due do kids, why did you make them in the first place? This is controversial and sligthly offtopic anyway.

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How a couple together can earn only 3400 CHF or 4500 CHF? Even at Migros or any shop or as a waiter you can get around 3800 CHF per month alone as 1 person.

If 2 people manage together to have 4592 CHF income together, and then even have children, then well, I don’t know much more what to say about it except for quoting Einstein: “Two things are infinite: the universe and human stupidity; and I’m not sure about the universe.

If a bank knows that their clients might have issues later this/next year, maybe they should inform their client to check their expenses. If the bank’s business plan is 90% lending money and 60% of its customers default, it’s not good news.

Maybe those 60% that will have issues need only to give back the 2nd car and stop paying expensive stuff in order to go back to a safe budget.

isn’t as well because an increase of interest rates makes the home value go down? Many may then need not only to pay 3 % of interest, but to add considerable capital to compensate for the value difference.

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To come back to the topic: Most of those that couldn’t afford interest rates at 3-4% are probably already retired. The others are just spending too much.

First group will be in trouble, second group will be forced to rethink their spending behaviour.

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Might be lack of financial education.

I’d say it’s rather a lack of common sense combined with gross negligence. And to know that any time I can’t pay my bills anymore, the government will step in, doesn’t help either. There are basically no consequences if you get into financial troubles.

The problem is easy to solve, you can either solve it on the government side (stopping to step in by cutting welfare costs) or at the bank’s side (asking customers for higher equity ratios e.g. 40% instead of only 20%, and lower the 33% costs part at 5% interest rate to 20%, and stop allowing 2nd/3rd pillar money to be used to buy real estate). I don’t want to regulate the banks, so I prefer the first option.

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I can absolutely confirm this behaviour within my friends, many of whom are expats working with Pharma/Finance/Banks in Switzerland.

Case in point: A couple earns approx. 25 KCHF per month net (after deduction of Pillar 1, Pillar 2, Health Insurance, IV, etc. but not taxes).

Their monthly savings is 5 KCHF.

Typical of their monthly expenses are: 1) 5.5 Apartment in Basel Stadt at 4.2 KCHF 2) Full-time Kita at 3.3 KCHF (even though they are not using the service) 3) paying for a nanny at 3.2 KCHF 4) lowest deductible health insurances at 1.5 KCHF 5) Full Batmaid service at approx. 1.2 KCHF, etc.

They recently bought a brand new hybrid SUV at 54 KCHF.

I brought up the FIRE philosophy with them a few months ago and they were totally dismissive of that idea, calling it unachievable. :thinking:

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