This guide explains how indirect amortization of secondary mortgages in Switzerland works, and clarifies the advantages and disadvantages. Amortizing your mortgage indirectly is often the most affordable option, but there are exceptions.
If you use a secondary mortgage to buy a house or apartment, you have to make mortgage payments to amortize the loan. Most Swiss banks let you choose between direct and indirect amortization.
What is direct amortization?
The first option is direct amortization. In this arrangement, you make regular mortgage payments to the bank in order to repay your secondary mortgage. In direct amortization, the mortgage debt decreases with every mortgage payment made across the mortgage term.
What is indirect amortization?
When you use indirect amortization, you also make regular payments. But instead of the payments going to the bank, the money is placed in the tax-privileged pillar 3a. This is done using a pillar 3a retirement savings account, a pillar 3a retirement fund, or a pillar 3a asset management service. The assets in the pillar 3a are pledged to the bank or other mortgage lender.
You only have to actually repay your secondary mortgage when you eventually withdraw your assets from the pillar 3a. So when you use indirect amortization, your mortgage is not actually repaid throughout the mortgage term. Your debt remains the same until your retirement assets are withdrawn, so you pay interest on the full loan until then.
Whether you use direct or indirect amortization, Swiss law requires that you fully amortize a secondary mortgage within a maximum of 15 years, but at the latest by the time you reach retirement age. If, for example, you get a secondary mortgage five years before you reach retirement age, then you have to repay it in full within five years.
What are the advantages of indirect amortization?
Paying off a mortgage indirectly using the pillar 3a has the following advantages:
As with direct amortization, indirectly amortized secondary mortgages have to be repaid in full within 15 years. But because your mortgage payments are placed in the pillar 3a rather than being used to repay your mortgage, you can deduct them from your taxable income (up to the limits for pillar 3a contributions). That results in a tax advantage.
Important: The tax advantage only applies if you would not otherwise use the pillar 3a and claim the tax deductions. It does not apply if you can afford to directly amortize your mortgage and still have enough money after your mortgage payments to save with the pillar 3a and claim the tax deduction.
With indirect amortization, you only repay your mortgage debt at all when you withdraw your pillar 3a savings. As a result, your interest costs, and subsequently the tax deductions you can claim for mortgage interest payments, are substantially higher. This is advantageous, from a tax perspective.
You can earn interest or returns on the money which you pay into the pillar 3a to indirectly amortize your mortgage. The higher the yields on your pillar 3a assets are, the more advantageous indirect amortization is, compared to direct amortization.
Here too, the advantage only applies if you would not otherwise be able to save using the pillar 3a on top of making your mortgage payments.
What are the disadvantages of indirect amortization?
Indirect amortization also has a number of disadvantages.
With indirect amortization, the mortgage repayment is only made when your pillar 3a assets are eventually withdrawn. Until that point, you pay interest on the entire secondary mortgage every year.
With direct amortization, on the other hand, your mortgage debt shrinks every time a mortgage payment is made, so the interest charges get steadily smaller over time.
When you withdraw your pillar 3a savings to repay your mortgage, you pay a retirement capital withdrawal tax. You do not pay this tax if you amortize your mortgage directly and do not use the pillar 3a. It is worth noting though that the retirement capital withdrawal tax is much lower than income tax.
Because your amortization payments are pledged to a lender, it can be difficult to terminate or refinance your mortgage.
Additionally, mortgage lenders typically require you to use their own pillar 3a products in order to indirectly amortize their mortgages. That is a clear disadvantage of indirect amortization, because in many cases, your mortgage lender will not necessarily have the highest pillar 3a interest rates or the cheapest pillar 3a investment solutions.
Which factors determine whether or not you should use indirect amortization?
Whether or not you can save money using indirect amortization, and how much money you can save, depends on multiple factors. Indirect amortization only makes financial sense if the total costs, accounting for all factors, are lower than the total costs of direct amortization.
The current interest rate environment, and particularly the annual interest rate applicable to your mortgage, plays a major role in determining if indirect amortization can save you money, and how much you can save compared to direct amortization.
Rule of thumb: The lower the mortgage interest rate is, the more likely you are to save money by using indirect amortization.
The reason for this is that when you amortize a mortgage directly, the amount you owe in mortgage debt keeps getting smaller with every mortgage payment. For example, halfway through the mortgage term you will only have to pay half as much interest as you do at the beginning of the mortgage term. With indirect amortization, on the other hand, you have to pay interest on the full secondary mortgage throughout the mortgage term.
Your personal tax burden (more precisely, your marginal tax rate) is a key factor. Your tax burden and marginal tax rate are determined by which canton and municipality you live in, and how high your income is.
Rule of thumb: The higher your tax burden and marginal tax rate are, the more money you are likely to save by using indirect amortization.
The reason for this is that because you pay more interest, you can claim higher income tax deductions than you would with direct amortization. Additionally, you can also claim the pillar 3a tax deductions (this is primarily relevant if you could not afford to save with the pillar 3a on top of making mortgage payments. So indirect amortization results in your having a lower taxable income. The higher your marginal tax rate is, the more you can save on taxes thanks to these tax deductions.
Unless you would both use direct amortization and save for retirement with the pillar 3a, indirect amortization is advantageous because you can earn yields on the money you pay in to the pillar 3a account or investment solution. The higher the yields you earn are, the more advantageous using indirect amortization is, compared to direct amortization.
Examples of direct vs. indirect amortization
In the tables below, you will find comparisons of total costs of direct and indirect amortization across a 15-year term, based on different examples.
All of the examples are based on a family with a home worth one million Swiss francs. The property is financed by a 650,000-franc primary mortgage, a 150,000-franc secondary mortgage, and a 200,000-franc down payment.
The family amortizes the secondary mortgage in full over the 15-year term in all three examples, as per Swiss regulations. This is accomplished by making mortgage payments of 10,000 Swiss francs per year. The mortgage payments are paid to the lender in the case of direct amortization, or are deposited into the pillar 3a in the case of indirect amortization. Note: Each of the two partners can contribute to the pillar 3a, so as a family, they can deposit up to double the annual pillar 3a limit.
Example 1: Average mortgage interest and average tax burden, with no pillar 3a contributions made in the case of direct amortization
This example is based on a mortgage interest rate of 3.5 percent per annum across the entire 15-year term, and average yields of 1 percent per annum earned on pillar 3a assets.
The marginal tax rate used for this example is 30 percent, which is the approximate tax burden of a household in Zurich with a taxable annual household income of 150,000 francs. For indirect amortization calculations, the 150,000 francs is the taxable income before deductions for pillar 3a contributions, and deductions for the difference in mortgage interest charges compared to direct amortization.
The calculations are based on the assumption that the family has only 10,000 francs per year available for mortgage payments and possible pillar 3a contributions, and that the family could not afford to contribute to the pillar 3a in addition to making their mortgage payments.
Comparison of total costs over 15 years
| Direct amortization | Indirect amortization | |
|---|---|---|
| Total interest paid for primary and secondary mortgages | CHF 383’250 | CHF 420’000 |
| Tax savings from higher mortgage interest charges | CHF 0 | CHF 11’025 |
| Tax savings from pillar 3a tax deductions | CHF 0 | CHF 45’000 |
| Yields earned on pillar 3a savings | CHF 0 | CHF 10’969 |
| Taxes paid for pillar 3a withdrawals | CHF 0 | CHF 8'511 |
| Total cost of mortgage | CHF 383’250 | CHF 361’517 |
| Money saved | CHF 21’733 |
In this example, indirect amortization has a clear advantage. The savings achieved by using the pillar 3a for indirect amortization outweigh the higher mortgage interest charges. Over the 15-year term, the family would save 22,000 francs by using indirect amortization instead of direct amortization.
Example 2: Average mortgage interest rate and average tax burden, with pillar 3a contributions being made in the case of direct amortization as well
As in the first example, the mortgage interest rate is 3.5 percent per annum, pillar 3a assets earn interest at the rate of 1 percent per year, and the marginal tax rate is 30 percent.
The only difference is that the family has 20,000 francs available each year.
In the case of direct amortization, the family spends 10,000 francs per year on payments for their secondary mortgage, and contributes the remaining 10,000 francs to the pillar 3a each year. This allows them to claim pillar 3a tax deductions, just as they could if they were to use indirect amortization.
If the family were to indirectly amortize their mortgage, they would only need 10,000 francs per year to both amortize their second mortgage, and to make pillar 3a contributions in order to benefit from the tax deductions. In this example, it is assumed that if the family were to use indirect amortization, they would not save or invest the remaining 10,000 francs.
Comparison of total costs over 15 years
| Direct amortization | Indirect amortization | |
|---|---|---|
| Total interest paid for primary and secondary mortgages | CHF 383’250 | CHF 420’000 |
| Tax savings from higher mortgage interest charges | CHF 0 | CHF 11’025 |
| Tax savings from pillar 3a tax deductions | CHF 45’000 | CHF 45’000 |
| Yields earned on pillar 3a savings | CHF 10’969 | CHF 10’969 |
| Taxes paid for pillar 3a withdrawals | CHF 8'511 | CHF 8'511 |
| Total cost of mortgage | CHF 335’792 | CHF 361’517 |
| Money saved | CHF 25’725 |
In this example, the household saves money by using direct amortization. They can contribute to the pillar 3a regardless of whether they use direct or indirect amortization. Although the higher interest costs of indirect amortization result in a higher tax deduction for interest charges, paying off their mortgage directly still works out cheaper because they avoid the higher interest costs altogether. Across the 15-year term, the family will save 26,000 francs by using direct amortization.
Note: If the family used indirect amortization, they would have an additional 10,000 francs per year available, which they could choose to save or invest. If they were to invest that money and earn an average annual return of 3 percent, they would earn 35,989 francs in total returns by the end of the 15-year term. In that case, indirect amortization would be 10,000 francs cheaper than direct amortization.
Example 3: Low mortgage interest rate and high tax burden, with no pillar 3a contributions made in the case of direct amortization
This example is based on a very low mortgage interest rate of 1.5 percent and a yield of 0.5 percent earned on pillar 3a savings across the full 15-year term.
The marginal tax rate used in this example is 37 percent, which is the approximate tax burden of a household in Geneva with a taxable income of 150,000 francs. For indirect amortization calculations, the 150,000 francs is the taxable income before pillar 3a tax deductions, and deductions for the difference in mortgage interest charges compared to direct amortization.
It is also assumed that the household has only 10,000 francs available each year for both repaying their mortgage, and contributing to the pillar 3a. The family could not afford to directly amortize their home and contribute to the pillar 3a as well.
Comparison of total costs over 15 years
| Direct amortization | Indirect amortization | |
|---|---|---|
| Total interest paid for primary and secondary mortgages | CHF 164’250 | CHF 180’000 |
| Tax savings from higher mortgage interest charges | CHF 0 | CHF 5828 |
| Tax savings from pillar 3a tax deductions | CHF 0 | CHF 55’500 |
| Yields earned on pillar 3a savings | CHF 0 | CHF 5365 |
| Taxes paid for pillar 3a withdrawals | CHF 0 | CHF 7087 |
| Total cost of mortgage | CHF 164’250 | CHF 120’394 |
| Money saved | CHF 43’856 |
In this example, the advantages of indirect amortization, compared to direct amortization, are very clear. Over the 15-year period, the family can save around 44,000 francs by using indirect amortization. Because the mortgage interest rate is low, the additional costs of using indirect amortization are relatively negligible compared to the high tax savings in Geneva.
Indirect amortization using pillar 3a investment solutions
In the examples above, the yields earned on pillar 3a assets are relatively low, which is the case when you use pillar 3a savings accounts. However, some mortgage lenders let you amortize your mortgage indirectly using investment solutions like pillar 3a retirement funds and pillar 3a asset management services. The possible advantage of investing the money you pay into the pillar 3a is that the returns can be much higher than the interest paid by pillar 3a savings accounts.
Important: While pillar 3a investment solutions can potentially deliver much higher returns than pillar 3a savings accounts, there is a risk of losing money. It is technically possible for your investments to lose value across the mortgage term. In the worst-case scenario, the value of your investments could shrink to where the money in your pillar 3a is no longer sufficient to cover your mortgage payments. In that case, you could be forced to find additional money to cover the difference.
Another disadvantage is that you are typically limited to using investment solutions from the same bank that holds your mortgage.
Conclusion: When is using indirect amortization worth it?
In most cases, amortizing your mortgage indirectly is the cheaper option.
If, after making your mortgage payments, you cannot afford to contribute the same amount of money to the pillar 3a or to invest the same amount of money elsewhere, then indirect amortization is practically always cheaper.
But, if after covering your mortgage payments, you also have at least the same amount of money available, then it depends on how profitably you can invest that surplus money. If you would earn little or no returns on the available money, then direct amortization works out cheaper. If, across the full term, you are able to earn a steady return (after costs and taxes) that is as high or higher than the mortgage interest rate you pay for your second mortgage, then indirect amortization is always more favorable.
Beware of conflicts of interest
Compared to direct amortization, Indirect amortization is much more profitable for banks and other mortgage lenders. In contrast to direct amortization, mortgage debt does not decline throughout the mortgage term. As a result, you have to pay interest on the full mortgage amount across the entire term. So the bank earns more interest without having to take on any additional risk.
Additionally, mortgage lenders may require you to use suboptimal pillar 3a solutions, such as low-yield pillar 3a savings accounts, or expensive retirement funds or cash-value life insurance policies.
As you can see in the examples above, indirect amortization can save you money in many cases, but not in every scenario. For that reason, you should carefully review your specific situation to find out whether amortizing your mortgage indirectly is in your best interests, or only those of your mortgage lender.
More on this topic:
Compare Swiss mortgage interest rates now
Compare pillar 3a retirement savings accounts now
Compare pillar 3a retirement funds
How to use Swiss pillar 2 and pillar 3a assets to buy property
When are early pillar 3a withdrawals allowed?
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