Should you invest all of your personal equity?

Author : Kristen

Should you invest all of your personal equity?

What to do if your personal equity exceeds 20% + 5%? Should you invest everything or only the required minimum? The real question is rooted in the taxation and return on the portion not invested in the property.

Taxation and return on non-invested funds

A fictional income is actually added to the taxable income as an additional net pay. This fictional income is the rental value calculated by each canton according to livable surface area, geographical location, environment, quality of construction and utilities, etc. In contrast, private debtor interest can be deducted (up to a taxable return on real estate and other property plus CHF 50,000, regardless of family status).

Therefore, the higher the amount of personal equity invested, the lower the debt and debtor interest. This will cause the income tax to increase. Conversely, the less equity invested, the more interest is deducted and the taxable income is reduced. The latter situation seems most appealing, but keep in mind that interest will have to be paid either way. On the other hand, if the equity that has not been put into the real estate is invested at a return higher than the mortgage rate, the operation is viable.

Marginal tax rate

In order to determine an efficient strategy, it is important to consider the marginal tax rate.

Total personal equity invested in a financial vehicule 

The following calculation allows us to demonstrate the minimum return on an investment if the total personal equity has not been invested in the real estate, but rather in a financial vehicule.

Example of financing: the desired property costs CHF 1,000,000 and 20% of personal equity corresponds to CHF 200,000. If income is sufficient to pay the 100% of the loan costs, the following choices are possible:

  1. Invest the CHF 200,000 in a real estate property and obtain a loan of CHF 800,000.
  2. Obtain a loan of CHF 1,000,000 while investing and using the CHF 200,000 as collateral.

In the second option, what must be the minimum return on investment to cover the CHF 200,000 increase in the loan?

Mortgage loan     800,000     1,000,000
Taxable income     200,000     200,000
Rental value   + 20,000   + 20,000
Gross taxable income   = 220,000   = 220,000
Mortgage interest at 2.60% fixed for 10 yrs (fictional rate)   - 20,800   - 26,000
Standard maintenance fees at 20% of the rental value   - 4,000   - 4,000
Final taxable income     195,200     190,000
Reduction of taxable income 195,200 - 190,000   = 5,200
Real tax savings with a marginal tax rate of 43.5% 5,200 x 43.50 % = 2,260
Additional mortgage insurance of
800,000 to 1,000,000 per yr
200,000 x 2.60 % = 5,200
Net increase cost for 10 yrs (5,200 - 2,260) x 10 = 29,400
Minimum return (in %, not including charges and tax) on a CHF 200'000 investment to obtain 29,400 after 10 yrs : 1.38%

The reduction from wealth tax has not been taken into account, as it is of minor importance.

We would like to note that in using assets as collateral, the collateral value must be considered in terms of the chosen investment profile. In this example, the value is 100%, however in terms of the investment and its risk, this value could vary between 50% and 100%.

Finally, you should be careful when selecting the type of investment because the return is often subject to income tax. A guaranteed ideal investment remains the maximum authorised payment through a 3rd pillar plan and the surrender of years from the pension fund, however, not all salaried persons have access to this benefit.

In all cases, you should set the maturity date of the loan to coincide with that of the investment because if the mortage interest rate is increased at the time of loan renegociation, you will probably have to proceed with an extraordinary amortisation in order to reduce the debt.

To summarize, in analysing a strategy in the smallest details of profitability and security, a minimum personal equity must be invested in the real estate property. A mortgage loan of 90%, or even 100% of the property value or purchase price is even recommended in order to make a good investment.

CALCULATE YOUR BUYING YOUR POTENTIAL

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