Buying or building your own home usually requires debt capital, which is provided by financial institutions in the form of mortgages. Mortgages are loans used to collateralize property. They are subject to the completion of a credit check: in addition to the property itself, the other key criteria are your financial and personal circumstances.
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How your creditworthiness affects mortgage conditions
Creditworthiness decides whether an applicant is offered a loan and under what conditions. This applies to both mortgages and private loans. Your creditworthiness is scrutinized closely before a loan is approved. But what exactly do these terms mean?
What does creditworthiness mean?
Creditworthiness or credit standing indicates the likelihood of customers repaying a loan. Applicants whom the lender deems trustworthy, reliable and “willing to pay” are considered creditworthy. Customers’ financial trustworthiness is examined. This covers payment behaviour history, but also outstanding liabilities and any debt enforcement or payment collection proceedings that are still pending.
Various statistical risk factors are examined as part of the credit check procedure. These include the following:
- Residency status
- Period of residency in Switzerland
- Frequency of change of place of residency
- Frequency of change of employment
To determine creditworthiness, lenders also contact the Central Office for Credit Information (ZEK) and consult sources such as the debt enforcement register and payment collection companies to obtain further information.
How does creditworthiness differ from borrowing capacity?
Applicants meet the creditworthiness requirements if they can legally conclude loan contracts. For example, they must be of legal age. The credit check also analyses the borrower’s financial situation: they must be able to repay the loan within the agreed term. Moreover, lending must not lead to borrowers becoming overindebted. The exact rules are set out in the Consumer Credit Act (CCA). As part of the credit check, a budget calculation is carried out, and the borrower’s expenses and income are compared. For example, expenditure includes:
- Living costs
- Health insurance premiums
- Any existing liabilities (such as alimony, maintenance)
- Commuting costs
Who checks the creditworthiness?
Applicants undergo a credit check each time they request a loan. This requirement must be met for a mortgage to be provided. The assessment of the applicant’s financial circumstances determines their credit rating. This classification decides whether they’ll be offered a mortgage and – if so – under what terms, including the loan amount, term and interest rate.
How is the credit rating determined?
It determines the mortgage conditions: applicants who achieve a high rating and are classified as creditworthy pay less interest on their financing solution. Those who don’t achieve the top score in all criteria can expect to pay a risk premium. Applicants must submit all documents, which are then used to assess all factors influencing the rating.
Which factors determine the credit rating?
Generally speaking, it is based on various factors, the first three of which carry particular weight:
- Affordability (percentage rate of gross income that the buyer must use on the property)
- Loan-to-value ratio (ratio of the mortgage to the property’s collateral value)
- Mortgage amount
- Collateral (such as other properties, life insurance policies or guarantees)
Can you work out your credit rating yourself?
No, the details of the lender’s calculations aren’t in the public domain. However, the key basic data used is known:
The borrower’s current income is a significant factor. Key employment data is also assessed: what is the borrower’s level of employment? Are both partners in a couple working? How secure is your income? Is there a risk of unemployment?
Another important factor is equity: how much equity is available? Are applicants providing the equity themselves, or is it coming from an inheritance or private loan? The applicant’s retirement planning situation is also evaluated (for example, is a pension fund or the pillar 3a being used to buy the property?).
Current financial obligations (leasing, alimony, debts, interest payments) and the savings ratio are checked. The applicant’s family situation is also taken into account: are there children who have to be supported?
Key data on the property being purchased is also looked at. If the lender believes that the purchase price doesn’t reflect the market value, they use their own estimates. How quickly a property could be resold in an emergency situation and the risk of its value falling in future are also weighed up. The property’s age and condition and maintenance and running costs are also factored into the assessment.
An imputed interest rate of 5 percent is used for the affordability assessment. Checks are made to determine whether the loan would still be affordable if interest rates rose or if the borrower’s salary level fell. Use our mortgage calculator to work out financial feasibility and the loan-to-value ratio of the property you’d like to buy.
How to improve your credit rating
The best way to improve your rating is by achieving a low loan-to-value ratio and a good affordability score. These are the factors you can change to improve your mortgage conditions:
- Loan-to-value ratio: the lower your level of debt in relation to your property’s value, the better your creditworthiness and the lower the lender’s risk. If you increase your equity with a family loan, for example, you’ll reduce the loan-to-value ratio and improve your rating. If you take out only a first mortgage (65 percent of the property’s value), you’ll benefit from a significant reduction in interest rate.
- Affordability: the higher the income you can include and the lower ongoing costs on interest payments and maintenance, the better your affordability score will be. For example, if you involve a joint debtor, you’ll reduce your lender’s risk and improve your creditworthiness and credit rating.
Questions and answers
Yes, contact your lender and explain that your income situation has improved significantly since your last credit check. This may happen if you earn more, if your life partner has returned to work, if you’ve received an inheritance or if you have new assets to use as collateral. You can also ask to have your property or apartment revalued if you think your lender’s valuation was too low last time or if its value has risen due to factors such as renovation work.