There are many aspects to consider when financing your own four walls: your savings and income, your household and lifestyle, and your longer-term financial planning. Both the bank and the customer want the financing to be supported by solid foundations.
When you start dreaming of your own home, you start picking up some technical terms, such as financial affordability, loan-to-value ratio and imputed interest rate. These are basic terms in the banking world, and they are essential when checking creditworthiness. Let’s start with the key term of affordability, which is the ratio of disposable income against the fixed costs of owning a home. Affordability is usually given as a percentage.
Affordability: the acid test for customers
The extremely low interest rates for mortgages would suggest that many people can afford to buy their own home today. In fact, the requirements of banks and other financial partners are actually very strict. After years of turbulent growth in the real estate and mortgage sectors, regulators are calling for caution. Under no circumstances should home loans carry the risk of private over-indebtedness.
The barriers to financial affordability have also increased, since property has become more expensive almost everywhere. Depending on the region and estimates, it is reported that only about 10%–20% of rental households can afford their own apartment or house. Twenty years ago, this figure was at about 50%. The exceptions are those inexpensive residential areas that tend to be in rural and mountainous regions away from the ‘hotspots’ of the real estate market.
Tip: you can obtain information without obligation from a customer advisor at a bank or an independent financial advisor; they know all there is to know about how banks check affordability.
If you’re brave enough to want to own your own home, you should first thoroughly plan and budget, and seek competent advice. If you don’t know what you can afford, do not rush into signing a reservation or purchase contract.
Affordability: what exactly does it mean?
The official guidelines of the Swiss Bankers Association state: ‘Affordability must be ensured in the long term, and thus must be based on sustainable income and expenditure components.’ The rule of thirds has proven itself in the specific implementation: the affordability of a home loan is verified if the total cost of home ownership does not exceed a third of the gross disposable income. Gross means income that is calculated before tax or social insurance contributions, such as old-age and survivors’ insurance (OASI) or unemployment benefits, are deducted.
In practice, you will probably ask yourself: what income is included in the affordability calculation and what is not? The principle is that income must be well documented and sustainable. Of course, you must be able to submit the relevant documents for close inspection, including payslips that indicate income from gainful employment. The salary for the 13th month is generally included in the calculation.
Possible bonus payments or a pending salary increase are partially taken into account provided that they are properly documented and paid out regularly. The same applies to the second income of a spouse. If you apply for a loan as a double earner, you will want to include the income of both partners. It is important to remember that a second income must also be properly documented and paid regularly. Another prerequisite is that the couple is jointly and severally liable for the loan.
Tip: ask your financing partner which documents are required. It is also important to know whether you need proof of income from just the previous year or several years. Self-employed workers must keep their accounting records (balance sheet, income statement, etc.) for several years. In any case, banks require a current extract from the debt collection register and a copy of the latest tax return.
Calculation of affordability: the costs
The documented income must be compared with different costs.
The mortgage interest is first to be considered. This often accounts for the lion’s share of the costs. Beware: do not use the current low interest rates for your budget. The authorising documents of the sector require the use of a ‘long-term imputed mortgage interest rate’. The interest rate included in the affordability calculation depends on the individual bank: an imputed interest rate tends to be between 4% and 5%.
Second, the prescribed and contractually stipulated loan amortisation must also be considered when budgeting. This must start no later than one year after the mortgage is paid out. For the budget, this means that you must be able to reduce the mortgage to two thirds of the property’s value within 15 years.
Plan for additional expenses
Third, the maintenance and additional costs of owning a home must be considered. It is customary in this sector to use 1% of the property value for this. For a new home at a purchase price of CHF 700,000, you would need to budget CHF 7,000 per year. This includes a wide range of expenses, including heating (energy supply, water), electricity, repairs, maintenance, gardening, building insurance and so on. If it is an apartment, the communal costs of the building are also included under ancillary costs. Of course, when planning thoroughly it is important to understand that additional costs can vary greatly in individual cases. For example, if the building is already 30 or 40 years old, it is likely you will pay more for building maintenance, repairs and heating.
Affordability: the reasons for conservative lending
Anyone who goes through this scenario often gets a nasty surprise. Perhaps the calculated costs are higher than they had hoped. The chances of securing a home loan are often better if you apply for a lower mortgage. By default, a bank funds about 80% of the purchase price, with 20% covered by your own funds. If you provide more of your own money (advance on inheritance, gifts, sale of securities, etc.), you can improve the affordability.
But there are at least three valid reasons for calculating the affordability of a mortgage conservatively:
- A reduction of the imputed interest would lead to even greater demand on the market. The banks and authorities want to avoid this overheating.
- An overly lax lending policy would be risky. A slight increase in interest rates of just 1%–2% would lead to a debt trap for many households and would not benefit anyone. A higher imputed interest rate reduces the risk of property ownership leading to over-indebtedness.
- The threshold of one third of gross income has proved its worth over the years. If a household spends more than a third of its disposable income on housing, it becomes financially tight. Who wants to cut back excessively on other fixed costs? All expenses for food, clothes, holidays, health insurance and other insurance policies, taxes, transport, further education, hobbies, free time, etc. also need to be covered.
Representatives of the authorities and the National Bank have stressed on several occasions that the conservative lending principles are ‘crucially important’. A relaxation would make both the banks and customers more vulnerable and would lead to greater risks.
Mortgage calculators help you to gauge your financial leeway: