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Created on 07.10.2019

How does a mortgage work?

Anyone dreaming of owning their own home will normally apply for a mortgage. But what exactly is the deal with this form of borrowing? Where does the idea of a mortgage come from, and how does it differ to a loan? Find out in this article.

What is a mortgage?

Mortgages are commonly understood as being loans on properties, though if we study the term more closely, this is not quite true. The reason is because it is in fact a charge that a “lender”  has on your property because he is giving you a  loan. And so, what is commonly known as a “mortgage” is actually called a “mortgage loan”. But that’s not the term we will be using here because at PostFinance, we simply use the more common term.

The various types of mortgage

A variable-rate mortgage, a LIBOR mortgage, an online mortgage or in fact a fixed-rate mortgage? The answer to this question isn’t easy, and this is why it is a good idea to get an understanding of the following terms first. On our mortgages page you will also find other information on the different types of mortgage available.

Fixed-rate mortgages with fixed interest

There are essentially two different mortgage models for property financing that the various offers are either based on or combine: fixed-rate mortgages and variable-rate or LIBOR mortgages.

One of the most popular choices for a first-time mortgage is the fixed-rate mortgage. This is a way of hedging against rising interest rates as interest remains unchanged during the mortgage term chosen. This means interest is generally slightly higher. It may be worthwhile taking a look at  online mortgages offered at favourable terms by banks.

Useful to know

Home owners can determine the duration of fixed-rate mortgages themselves. In times of persistently low interest rates, long-term durations are especially sought after. PostFinance offers fixed-rate mortgages with durations of up to 15 years. For those taking out a mortgage, this means that – thanks to the fixed interest rate – they can budget their housing costs precisely, and have a grasp of their financial obligations for the years to come. This creates planning security and alleviates stress.

Here’s our tip for buying your own home: make sure you check the terms and conditions should you decide to back out early on, especially if the mortgage term is long.

Variable-rate mortgages with variable interest

Variable-rate mortgages generally involve an unlimited mortgage term and can be cancelled very quickly with your bank (usually within the space of six months). The benefit of this mortgage is you can back out early on and make a quick switch to other types of borrowing. Even though the comparably favourable interest rates are advantageous in this case as the bank is free to set them, unlike with a long-term fixed-rate mortgage, this option does not offer as much planning security. Even the really low interest rates seen over recent years could give way to increasing interest rates in the next few years.

LIBOR mortgages with money market interest rates

Alternatively, many opt for a money market or LIBOR mortgage from their bank. These offer a variable and usually more favourable interest rate seeing as they entail fixed but shorter mortgage terms than a fixed-rate mortgage. This is due to the conditions under which the banks grant each other interest on the London Stock Exchange, and is why, when it comes to LIBOR mortgages, we refer to the “money market interest rate”. This product is a good option for customers who assume interest rates will not increase over the next 1 to 3 years.

Useful to know

It is expected that the widely-used reference interest rate LIBOR (LIBOR = “London InterBank Offered Rate”) will be replaced (in German) by a different interest rate in 2021. In Switzerland, Saron (Swiss Average Rate Overnight) is currently already looking poised to be a promising successor to LIBOR. For variable models that usually have a three-year mortgage period, this is something you should definitely consult your financial advisor about beforehand.

Tranching: splitting a mortgage up into different mortgage terms

Splitting up or combining these two mortgage types is often advisable, and can be well worth it.

This process involves splitting a product into two or more tranches (from the French meaning “slice”) with different mortgage terms. The benefit of doing this is that a mortgage customer will not have to roll over their entire mortgage at the same time, which means they can respond more flexibly to interest and to their current circumstances.  This can, however, come with certain disadvantages, for example if a person decides to switch to a cheaper provider or if they decide they would like to synchronize the terms of their current mortgage.

Useful to know

Start keeping track of  affordability and your loan (i.e. for the sum you are not covering with equity) at an early stage for your property.  The PostFinance mortgage calculator will help you find favourable conditions.

Equity: your own monetary share of the purchase price

Equity indicates the total amount of equity available for the purchase of a property, and 20% of funding must be covered by equity. But this can come from various sources. However, 10% of the property’s value/purchase price must be covered by genuine equity. This may comprise:

  • Your own savings
  • Securities such as shares
  • Gifts/advances against inheritance
  • Assets from pillar 3a

Useful to know

if the owner lives in the property themselves, the additional 10% of the purchase amount can also be paid via the advanced withdrawal of their pension fund or by pledging it. However, this does not apply to the purchase of holiday apartments or properties acquired for rental purposes only. It is a good idea for people close to retirement age and families with minors in particular to carefully consider the potential risks.

Affordability: your own requirements for being able to pay off the interest on your mortgage

There are additional costs besides equity: for one thing, there is the interest that needs to be paid on the mortgage to the bank or lender. Then the mortgage itself must be paid off, which is known as  amortization. Lastly, home upkeep will also be quite a hefty expense. Every one of these costs must be “affordable” with your available income.

As such, affordability refers to the ratio between expected income and costs incurred, and for them to be “affordable”, they should not constitute more than a third of your (joint) gross annual income.

Useful to know

Due to interest rate fluctuations, it makes sense, especially with variable money market mortgages, to assume a higher interest rate than the rather low mortgage interest rates (in German) we are currently seeing. This is why, when calculating interest, banks use what’s known as an imputed interest rate as a basis, which is currently around 5%.

A big step for life

The idea of a mortgage is to make things easier for you at home, whether it’s a house or an apartment, and not to give you an extra burden in your everyday life. Before you borrow, it’s important to do plenty of research into this type of loan and to set aside enough equity to cover it.

It is not always worth investing in a new home. Maybe renting would be cheaper for you? Switzerland is still a country of renters compared with the rest of the world seeing as its rate of home ownership is only about 40%. This is why it is a good idea to do plenty of research and to seek advice. The Federal Office for Housing offers interesting information on the topic, suggesting when it’s better to The link will open in a new window rent than to buy (in German).

But owning your own home is not just about banks and money. In addition to the financial side, having your own property is also a major step in life. If you decide home ownership is the way to go, you are also choosing a certain way of life. So, take your time making this decision so that the obstacles to taking out a mortgage do not become a major issue.

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