What is mortgage affordability?
Affordability in a mortgage refers to a potential homebuyer’s ability to comfortably manage the costs associated with purchasing and maintaining a home, given their income, expenses, and other financial commitments.
Calculating a homebuyer's affordability is a crucial step that any Swiss bank or insurance company will undertake before granting a mortgage loan. For safety of the financial system, Swiss lenders are subject to very stringent criteria when it comes to the affordability of mortgage loans.
Calculating the affordability of your mortgage in Switzerland
Easily calculate the affordability of your mortgage loan in Switzerland using our free affordability calculator available here: https://strike-advisory.ch/en/real-estate-financing#affordability-calculator
What factors influence the affordability of a mortgage?
There are two main factors that go into determining the affordability of a mortgage in Switzerland: Your cash or equity with respect to the purchase price, and your income with respect to the ongoing costs of owning the property.
In Switzerland, a mortgage loan can under most circumstances not exceed 80% of the property value or purchase price, whichever is lower. This means that 20% of the purchase price must be paid in cash. Please find more information about loan-to-value ratios as they relate to mortgage loans in Switzerland in our dedicated article.
The second criterion for mortgage affordability is the ongoing costs associated with the loan and the property. In Switzerland, this is referred to as Tragbarkeit or Capacité d'achat in German and French, respectively. When calculating the affordability of a mortgage loan, your lending institution will compare your income to the expected costs of owning the home in question. As a rule of thumb, the ongoing costs of owning a home should not exceed one-third of your gross income.
Details of how banks determine affordability of a mortgage
As stated above, the affordability threshold for a mortgage is generally at one-third of gross income or below. The details of how the monthly expenses are calculated can be quite complex. The ongoing cost commonly considered by banks include:
- Imputed mortgage interest: Mortgage affordability in Switzerland is not based on real interest rates, but on an imputed interest rate of around 5%. As this rate is much higher than current rates, affordability is ensured even if mortgage rates rise.
- Amortisation payments: In Switzerland, homebuyers do not redeem the entire mortgage over the course of the term due to the tax benefits offered by being in debt. However, the so-called 'second mortgage', which is the part of the loan exceeding two-thirds of the property value, must be redeemed within 15 years or upon reaching retirement age (whichever is first).
- Utility costs and maintenance: This includes heating and electricity, as well as maintenance work on the property. Most financial institutions estimate these costs around 1% of the property value per year.
Why are affordability criteria as they are in Switzerland
It is certainly true that Switzerland has some of the most restrictive affordability criteria in the world. Along with record-high real estate prices – especially in major cities like Zurich and Geneva –, this poses a significant entry barrier to prospective buyers. Along with a healthy rental market, this results in one of the lowest homeownership rates of any country.
However, there are good reasons for affordability criteria being as they are. Most notably, both the 2007/2008 global financial crisis as well as the early 1990s Swiss recession were triggered by bursting real estate bubbles, which were in part made possible by lax affordability standards. The stringent affordability criteria were put in place to protect the financial system and mitigate the risk of future real estate bubbles.
Different affordability standards of different banks
First of all, it is crucial to understand that general affordability criteria are set by law. If your income or equity is significantly lower than is required by affordability standards, a Swiss financial institution has no choice but to deny your mortgage application.
However, financial institutions do have some leeway when it comes to affordability. Most importantly, as affordability standards are only approximate guidelines, there are significant differences between lending institutions. Here are some real examples of different affordability standards as used by different banks and insurance companies:
- Some lenders allow ongoing costs to be as much as 38% of income, while others will never go beyond 33%.
- Some lenders will calculate affordability based on gross income while others will use net income.
- Not all lenders will value all types of assets and income the same way.
- The imputed interest rate varies depending on the bank or insurance. With some lenders, it may be as low as 4.5%.
- Maintenance costs are estimated differently by different lenders. They may also depend on the age of the property.
What to do when a bank has denied a mortgage because of affordability
If your bank or insurance company has denied your mortgage application due to affordability, you have several options available. In any case, this does not necessarily mean that you will be unable to purchase a home. Sometimes, it just means looking for a different lender or changing your strategy. Here are some key tips for improving your affordability:
- Increase your equity/down payment: The more of the purchase price you pay in cash, the smaller your mortgage loan will be. A smaller loan means lower monthly costs, making the loan more affordable.
- Inquire with another financial institution: As stated above, affordability standards vary between lenders. If one bank or insurance has denied your mortgage, another may very well approve it.
- Improve your application and documents: By submitting a comprehensive file, you significantly increase your chances of having your application approved.
- Work with a professional: A financial advisor or mortgage broker will prepare your application and negotiate with various lenders for the best mortgage rates and terms. With their extensive network of lenders and knowledge of the market, they will be able to secure deals on your behalf that the financial institutions may not have offered to you otherwise.
