Mortgage loan

News from DL MoneyPark and information on the financial market and Swiss romande real estate

Author : Kristen

Terminate a fixed-rate loan

In the case of a fixed-rate mortgage termination before the loan expires, the financial institutions will require a penalty or an exit indemnity.

This penalty depends on the refinancing rate, the margins that apply to the client, the return on the financial institution's reinvestment, and the administrative fees. You should know that when a bank grants a loan, it will borrow on the capital market itself. Then it will add its own margins and offer you the mortgage rate. Let's look at the following example:

Our client has fixed his rate for a duration on 10 years at 3.85%. The bank's refinancing rate at the time of reservation was 3.00%. The bank's margin for the entirety of the fixed rate duration is 0.85%.

Let's imagine that the fixed rate is terminated 4 years before its expiration date, or the date that the loan is reimboursed to the bank. Always looking out for its own interests, the bank now has access to the reimbursement amount. This sum will be placed on the capital market (investment type in CHF, without risk) for the remaining period on the original contract, thus 4 years. Let's say for example that the return on the capital market for the remaining time is 1.75%.

Difference for the bank :

A) For its refinancing rate (3.00% – 1.75%) = 1.25 % (loss for the bank)

B) For the client's rate (3.85% – 3.00%) = 0.85 % (loss in earnings)

Total loss + loss in earnings (0.85% + 1.25%) = 2.10 % (total difference)

In most cases, the bank charges options A+B to the client, in other words an indemnity of 2.10% is calculated on the mortgage loan amount, multiplied by the remaing days on the contract. This covers the bank's loss as well as the loss in earnings, distributed across the entire loan term (in our example, this would mean a penalty of CHF 50,400 on a loan of 600,000). In addition, the administrative fees can be billed to the client (to the tune of CHF 1,000). This calculation is an example and should not serve as a basis of calculation for your case. In all cases, you should ask how high the exit indemnity is at your financial institution. Once you know this amount, you can perform a detailed calculation.

In our example, the client would obtain today a 4-year fixed rate at 2.20%. So, does it pay to break the current fixed rate, pay the penalty, and obtain refinancing at 2.20%? In order to make a detailed calculation, we will take into account a marginal tax rate of 41% (a rate that approximately corresponds to the situation of a married couple with 2 children living in Geneva with a taxable income of CHF 150,000).

Interest payable at a rate of 3.85% : 

(600,000 x 3.85%) x 4 years  = 92,400

Interest payable at a rate of 2.20% :

(600,000 x 2.20%) x 4 years =  52,800

Savings on interest :

92,400 - 52,800 =  39,600

Net exit indemnity :

50,400 - (50,400 x 41%) = 29,736

Tax loss on interest :

(600,000 x (3.85% - 2.20%)) x 41% x 4 years = 16,236

Final result

39,600 –29,736 –16,236 = - 6,372

In this example, we would say that it is not in the client's interest to change rates, but only because the exit indemnity is substantial. If this indemnity were lower, for example if the financial institution did not deduct its margin, the calculation could be more profitable. Furthermore, we will not consider the advantage of a mortgage rate with a longer duration.

In most cantons, the exit penalty is, in theory, deductable from the taxable income just as is debtor interest. The maximum deductible amount, increased to CHF 50,000, corresponds to the return on real estate and other property value.

It should be noted, however, that in very specific cases the financial institution may partially or even completely waive the penalty. The opposite may also occur, meaning that the bank refunds money to the client because the financial investment pays more than the refinancing rate.

Finally, in order to avoid penalties in selling your own property, you could resume your current rate for the new property as long as the financing value is identical to or higher than the current one. It would also be possible for the new buyer to resume the conditions all ready in place provided that they suit his personal situation.

Ultimately, we conclude that breaking a fixed-rate credit contract may involve substantial or heavy penalties. In order to define the best strategy,

DL MoneyPark will help you analyse your specific loan terms, the market terms, your personal situation, and especially your tax situation.

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