Direct vs. indirect amortization of mortgages

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Direct vs. indirect amortization of mortgages

In Switzerland, buying a home is a big step in life for many people and a long-term investment. Most Swiss people need a mortgage to finance the purchase of their dream home. There are several options available when taking out a mortgage, including direct and indirect amortization. In this blog post, we will explain the differences between these two approaches and find out which one is best for your financial situation.

What is a mortgage?

Before we turn to the two types of amortization, let's briefly clarify what a mortgage is in the first place. A mortgage is a loan granted by a bank or other financial institution to finance the purchase or construction of a property. In return, the borrower agrees to repay the loan plus interest. The way you repay your mortgage can have a significant impact on your financial stability.

Direct amortization: the traditional method

Direct amortization is the traditional method of paying off a mortgage in Switzerland. With this approach, you repay a fixed amount each month, consisting of a portion of interest and a portion of principal. Over time, the interest portion decreases while the principal portion increases. This means that you will reduce your mortgage over time and eventually become debt-free.

The advantages of direct amortization are:

1. clear debt reduction: as you make regular principal repayments, you know exactly how much you still owe and can better plan your financial future.

2. interest savings: as the outstanding balance on your mortgage decreases, you will pay less interest over time, which can result in significant savings.

3. financial security: over time, you build property, which provides you with some financial security.

Indirect amortization: The alternative option.

Indirect amortization, also known as a "pillar 3a mortgage" or "LOB mortgage," is an alternative method of paying off your mortgage. With this method, you save money in a tied pension plan (Pillar 3a) and use it to pay off your mortgage in one fell swoop at the end of the term.

The advantages of indirect amortization are:

1. tax advantages: Payments into Pillar 3a are tax deductible, which can reduce your tax burden.

2. flexibility: you have the flexibility to pay money into your pension plan when your financial situation allows and pay off the mortgage at the end of the term.

3. inheritance planning: in the event of death, Pillar 3a funds can be transferred to heirs, which can play an important role in your long-term financial planning.

The choice between direct and indirect amortization

The choice between direct and indirect amortization depends on several factors, including your financial goals, your current financial situation and your risk tolerance. Here are some considerations that may help you decide:

  • Financial stability: If you are financially stable and can easily meet monthly mortgage payments, direct amortization may be a good choice.
  • Tax advantages: If you want to take advantage of tax benefits and have the flexibility to contribute money to Pillar 3a, indirect amortization may be attractive.
  • Risk tolerance: Indirect amortization may be riskier, as you may be left with a substantial amount of money at the end of the term.
  • Long-term goals: Consider what your long-term financial goals are. Your choice of amortization method should fit your goals.

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