Income usually drops after retirement. Homeowners should therefore check in time whether their mortgage will still be affordable after they retire. Read here how to calculate correctly and take precautions in good time.
Enjoying retirement in your own home – many seniors eagerly anticipate a life of leisure after a lifetime of work. They look forward to spending their free time at home, content in the knowledge that they have provided well for themselves by buying their own property.
But often retirees realize, only after being notified by their bank, that they no longer can afford their mortgage because their income in retirement is too low. Because it is known that income declines when a person retires, many lenders perform a detailed affordability calculation at this juncture. The central question for every prospective retiree is therefore whether their current mortgage is affordable on their retirement income – which is often lower.
To ensure affordability, mortgage interest and maintenance costs should not exceed one third of (pension) income. However, income shrinks when income from employment is replaced at retirement by benefits from old-age and survivors’ insurance (AHV), the pension fund and capital payments. The standard assumption is that income will be reduced by 30%. Additionally, lenders only provide mortgage loans to retirees up to a maximum of 65% of the property value, instead of the previous 80%.
The following table illustrates the situation before and after retirement:
Before retirement |
After retirement |
|
Value of the real estate |
CHF 1,000,000 |
CHF 1,000,000 |
Mortgage amount |
CHF 700,000 |
CHF 650,000 |
Imputed interest (5%) |
CHF 35,000 |
CHF 32,500 |
Required amortization per annum |
CHF 10,000 |
—— |
Imputed maintenance costs |
CHF 10,000 |
CHF 10,000 |
Total imputed costs |
CHF 55,000 |
CHF 42,500 |
Required income |
CHF 165,000 |
CHF 127,500 |
The total costs consist of an imputed interest rate of 5% for the mortgage, imputed maintenance costs of 1% of the market value and the amortizations. Lenders require that imputed costs not exceed a maximum of one third of regular income. With imputed costs of CHF 55,000, income would therefore need to be around CHF 165,000. Assuming a mortgage was barely affordable at this income and deducting the usual 30% from it at retirement (pension: 115,000), the mortgage would no longer be considered sustainable, as the minimum income calculated for it is CHF 127,000.
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The following tips can help you meet affordability requirements before you retire.
Many banks not only apply the affordability calculation based on pension income at the start of retirement, but also make this calculation as soon as a mortgage-holder turns 50. In short, it’s never too early to address what your financial situation will be after you retire.
If it becomes clear that your mortgage may be too expensive given your expected retirement income, you still have time to take action.
Though retirees are frequently wealthy, they often don’t have many liquid assets, having invested their assets in the repayment of the mortgage. The problem is that they may find it difficult to add to their mortgage in order to finance a renovation or a conversion. In certain financial situations, we recommend maintaining the higher loan-to-value of an existing mortgage rather than adding to a loan, most of which has already been paid off.
For example, borrowers who realize ahead of time that their mortgage will be too expensive after they retire still have the opportunity to build up their liquid assets from the age of 50. They can do this by regularly paying into pillar 3a or by closing gaps in their pension fund by making retroactive payments – provided the conditions offered by the fund are attractive.
A popular method of ensuring sufficient liquidity in retirement is through indirect amortization. With this form of amortization, the amount of mortgage debt stays the same over the entire term and accordingly so do the mortgage interest rates. Instead of making regular amortization payments to the lender, the amounts owed are paid into a pillar 3a retirement account.
This results in two tax advantages: Both the interest payments and the payments into the pension account can be offset against taxes. The money saved can then be used later to repay the mortgage. Ideally, the calculations are made so that the mortgage is so low in retirement after amortization payments that the interest payments remain manageable.
Some retirees are inclined to fix their mortgage interest rate for as long as possible. However, this has two disadvantages: Fixed-rate mortgages are usually more expensive than money market mortgages. Some homeowners move into a condominium after retirement – because they need less space. However, not all banks are willing to transfer fixed-rate mortgages to a new property. In a worst-case scenario, the mortgage will need to be terminated prematurely, which typically comes at a high cost. Money market mortgages, on the other hand, are usually cheaper and more flexible.
If your pension is too low to meet the affordability criteria for a new mortgage, one practical option is to transfer ownership to relatives, for example to your children. If they earn a regular income, they will usually also satisfy the requirements of the affordability calculation. Although the children will then own the house, the parents can enjoy a lifelong right of residence, which can be stipulated in a contract.
Real estate prices have continued to rise in recent years, which implies that privately owned properties have also increased in value. This does not apply to all properties without exception, but it does apply to many. Therefore, it may be worthwhile to have your property re-assessed. If the value of your property has gone up, your loan-to-value ratio and credit rating will also improve – which will in turn be rewarded with lower mortgage rates.
It is clear that early retirement planning is important to maintaining a comfortable standard of living in retirement. Careful planning, a broad-based investment portfolio, early amortization or closing gaps in your pension fund are all ways you can prepare for retirement when it comes to calculating affordability. It is best to get advice early and take the steps mentioned in good time.
