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Home ownership
If you own your home and have liquid funds, you can use your money more profitably than to pay off your mortgage – for example, to build up your wealth. Thanks to lower mortgage interest rates, this strategy is now even more attractive.
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Owning a home represents both a risk and an opportunity for building personal wealth. On the one hand, real estate ties up a lot of capital and, due to this concentration, it presents a “cluster risk” for asset growth. On the other hand, in combination with a mortgage, it offers a useful tool for building up additional wealth.
People who live in their own home often manage to build up considerable liquidity reserves over the years – despite the mortgage debt. Before 2022, for example, low usage costs of owner-occupied homes made this possible. When it’s time to renew a mortgage, the question arises as to whether or not to use the accumulated liquidity reserves for the amortization. If yes, these reserves would then also be tied up as equity in the property, increasing the cluster risk.
An alternative is to forgo voluntary amortization. If you extend the mortgage, you can invest your liquid assets in other, higher-yield investments. And if your loan-to-value ratio is low, you might even consider increasing your mortgage. The calculation to make is the following: if the expected return on the investment is higher than the cost of the mortgage, the investment is worth it.
The strategy of using mortgages in this way to build wealth has become even more attractive in 2024 because mortgage rates have fallen substantially, and declines in the nominal value of owner-occupied homes across the market as a whole are not expected in near future due to the housing shortage.
How much could the strategy of using your mortgage to accumulate wealth in the long term pay off for you? This is illustrated by the following example: A home has a value of CHF 1 million. The mortgage is 60 percent of the property value and, for the sake of simplicity, let’s assume the liquid assets are also CHF 600,000.-. We will also assume that the value of the home will increase by around 2 percent per year in the long term and that the value of a diversified Swiss equity portfolio will increase in line with current market expectations.
When it comes to using the surplus funds, the household in question has – in simple terms – three strategies to choose from: liquidity, repaying the mortgage or investing the liquidity reserves.
Strategy | Retain the liquidity | Amortize the mortgage | Invest the liquid funds | ||||
The combination of cash and mortgage yields the lowest return in the long term. Mortgage interest rates reduce the effect of the increase in value. The expected total return per year is equivalent to the increase in property value less mortgage costs. | The mortgage amortization reduces the interest burden. The expected total return corresponds to the increase in value of the property. | If the potential investment income is significantly higher than the interest payments, this results in the highest expected total return. | |||||
Total return per year | 1.4 percent | 2 percent | 3.8 percent |
This investment strategy is not a short-term option, but aims to generate returns, particularly in the long term. After ten years, the difference in returns would be significant: the household considered in this example would have increased its wealth by around CHF 250,000 by investing its liquid assets.
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Long-term earnings are necessary for the success of this investment strategy. Which investments can homeowners use to achieve these returns? In the example, the liquid funds were invested in a diversified, balanced model portfolio of Swiss equities. For such a diversified equity portfolio in Swiss francs, the expected long-term annual return is 6 to 7 percent. A high proportion of equities can be particularly attractive for owners under the age of 50 because they have a comparatively long investment horizon.
However, because the volatility of the invested assets increases the higher the share of equities, it can make sense to use some of the surplus funds for lower-risk investments. If, for example, half of the investment is invested in Swiss bonds and half in equities, the expected long-term return is just under 4% per year. However, this would mean that the average return would probably still be significantly higher than the average mortgage rate of 1.7 percent (fall 2024).
Before opting for this investment strategy, you should be aware of the potential risks. The biggest risk is a significant rise in interest rates and thus mortgage costs. This would not only put a strain on your household budget, but would also lower the value of your home and investment portfolio. In the example above, an increase in mortgage interest rates to 3 percent, weak stock market performance and a lack of growth in the value of your property over ten years would lead to a total return of 0 percent. Risk-averse buyers and investors therefore tend to choose lower loan-to-value ratios with fixed conditions. In the case of mortgages, staggered termscan be worthwhile. This can reduce the risk of refinancing the entire mortgage at an unfavorable time.
Regulatory measures are also intended to protect against an excessively risky combination of high real estate debt and stock market investments. For example, the self-regulatory rules of the Swiss Bankers Association (SBA) stipulate that mortgage debts for owner-occupied homes must be repaid within 15 years on two thirds of the loan-to-value ratio. In addition, the imputed costs of the mortgage may not exceed one third of income based on the affordability calculation. This limits the maximum loan-to-value ratio.
A constant, moderate loan-to-value ratio is financially attractive for many homeowners and frees up funds for high-yield investments. Successful investors can look forward to an increase in assets even after deducting all costs.
Possible taxesdo not change this advantage. As is known, homeowners have to pay tax on the imputed rental value and can deduct mortgage interest in return. However, as you will owe tax on your imputed rental value either way, this should not be a criterion for deciding how to use your liquid assets. If, on the other hand, you remain passive and do not invest surplus funds, you are missing out on potential capital gains.
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