In less than a year, we have moved abruptly from an environment of negative interest rates to one of positive rates. In Switzerland, the Swiss National Bank (SNB) began to raise interest rates in June 2022, raising its key rate by 50 basis points, from -0.75% to -0.25%. In June 2023, the rate is currently 1.5%, and further rises are envisaged.
Many homeowners who have taken out a mortgage and are facing mortgage repayments are wondering what they should do: Repay if they can? Renew? If so, with SARON (Swiss Average Rate Overnight) or with fixed rates? And for how long? These are the kinds of questions that also arise when you want to buy a property.
In this article, I shall look back at the reasons behind this recent development and give some food for thought to help answer the above questions, bearing in mind that any decision should be made in the light of your specific situation.
Article written by Brigitte Borel, President of the Association of Property Owners of Chalets and Apartments in Verbier and the Commune de Val de Bagnes.
Origin of the rise in rates
There is a lot to be said on this subject. The main reason for rate rises by central banks, whether the US Federal Reserve (Fed), the European Central Bank (ECB) or the Swiss National Bank (SNB) is inflation. It was said at the time that inflation would be transitory, having appeared in 2021, but this has proved not to be the case. Raising interest rates is one of the main tools available to central banks, as guarantors of monetary stability, to curb inflation. Where does this inflation come from? It is caused by two factors that influence prices: supply and demand. On the supply side, we can point to the problems in supply chains during the Covid crisis and the rise in energy costs following the outbreak of war in Ukraine. However, it is the previous actions of these same central banks in the USA and Europe that have driven up prices since 2021. For years, and particularly during the Covid period, they have been constantly creating money to support the economy. This is known as quantitative easing (QE). Boosted by these measures, the financial markets, against all expectations, posted bold gains until the end of 2021, but this could not last. Acting on the demand component of inflation, gargantuan money creation and cheap credit eventually created an imbalance leading to inflation. We need to act quickly and decisively, because price stability is an essential condition for growth and prosperity. It is also essential for confidence in fiat money, which, with the exception of Zimbabwe, no longer has any intrinsic value following the US decision in 1971 to end convertibility between the dollar (USD) and gold. In Switzerland, the gold standard was definitively abandoned in 1973. It should be noted that if the population were to lose confidence in its currency, this could lead to hyperinflation. Germany had to deal with this phenomenon at the end of the First World War as a result of excess money production and an inelastic supply due to shortages.
So central banks opened their toolboxes and raised interest rates to cool the economy. The Fed has raised rates 10 times since March 2022, pushing the key rate up to between 5% and 5.25% in March 2023, its highest level since 2006. The ECB has raised rates to between 3.25% and 4% and the Bank of England to 4.5%. The SNB followed suit, albeit to a lesser extent, as inflation in Switzerland remains at a level that can be described as reasonable, even if it is outside the price stability range of 0-2%.
The double Kiss Cool effect of the Fed’s monetary policy
The decisions taken by the US central bank have produced effects that go beyond the factors it wanted to influence, currently inflation. One of the consequences of recent rate rises has been their impact on the bond market. When interest rates rise, bond prices fall. Why does this happen? Because investors prefer to buy new bonds issued at higher rates, which reduces the value of existing bonds. The SVB (Silicon Valley Bank) in the USA has paid the price, having invested a lot of its depositors’ money in long-dated bonds. Given the rise in interest rates, the bank had to cope both with withdrawals from its depositors – the vast majority of whom were start-ups also affected by the rise in interest rates – and with a fall in the assets on its balance sheet, due to the decline in the value of the bonds. Even if we can question the wisdom of the SVB having invested in this type of long-term investment, the fact remains that the rise in interest rates was the cause of this debacle, which had not been anticipated by the Fed, which has since come to the rescue of the SVB. At the same time, other banks failed in the USA and a global banking crisis ensued. With central banks and governments demonstrating their determination to support the banking sector at all costs in order to restore confidence, there is every reason to hope that the banking crisis has been contained. For some analysts, this heralds the imminent end of the rate hike cycle. Indeed, if banks want to be prudent, they will have to clean up their balance sheets. They will lend less, which in itself will be a factor in slowing down the economy, just as rising interest rates are.
Ever greater complexity
It is worth noting that even if the underlying mechanisms of inflation are simple to understand on their own, the sheer number of variables involved and the way they combine to form a complex system makes it all the more difficult to analyse given that we are currently experiencing a period of transition in several respects. Global warming is an inflationary factor. It will lead to higher food prices, among other things. Technological advances, in particular the emergence of artificial intelligence, can be a deflationary force by guaranteeing productivity gains. Geopolitical factors, with new global balances and alliances, and demographic factors will also have an impact on inflation. These factors and their evolution are taken into account by the SNB when determining its monetary policy.
The case of Switzerland
Thanks to the SNB’s decisions, which encouraged the franc to appreciate on the markets, inflation has been kept under control in Switzerland. Because we are a small economy open to the outside world, the SNB intervened on the foreign exchange market to achieve its objectives. Maintaining a strong currency acts as a brake on imported inflation. In addition to monetary stability, Switzerland also benefits from political stability and the security provided by its legal and fiscal framework.
What is the outlook for interest rates, particularly mortgage rates?
No one is in a position to predict exactly how things will develop. The most widely accepted assumption is that further limited rises can be expected in 2023, and that rates could fall again from 2024 onwards. In Switzerland, provided our domestic economy continues to perform well and inflation remains under control, this should be the case.
Against this backdrop, what should you do if you need to renew a mortgage or take out a new one?
As fixed mortgage interest rates in Switzerland have been in line with the SNB’s expectations of rate rises for some time now, there are no major increases to be expected. In the light of recent events, decreases could be possible in 2024, bearing in mind that we have seen substantial variations in mortgage interest rates from one day to the next in recent months. It should be noted that, despite their recent rise, fixed rates remain historically low. The advantage of fixed rates is that they can be budgeted for with certainty, which can be reassuring for those wishing to plan their spending. Mortgages in Switzerland can be taken out for periods of between 1 and 15 years, or even 25 years with some providers. They can be renewed, although not systematically. If you terminate your mortgage early, for example if you decide to sell your property, a penalty may be payable, which may be deducted from the capital gain for tax purposes. However, if you are lucky enough to have taken out a mortgage during the period of negative interest rates, you may consider passing it on under certain conditions to the buyer of your property, which could be an advantage in the sale.
Alternatively, you can opt for a SARON mortgage. The rate you pay is the SARON rate, i.e. 1.44% at the time of writing (https://www.snb.ch/fr/iabout/stat/statrep/id/current_interest_exchange_rates#t2) plus a fixed margin agreed with the bank. SARON is an interest rate for overnight loans. It closely tracks the SNB’s key interest rate. If you take out such a mortgage, you will be able to choose between different settlement periods, ranging from 1 to 3 months. You will not know the interest rate paid until the end of the settlement period. The advantage of this form of money market mortgage is that, in principle, it benefits from short-term rates that are lower than long-term rates. The disadvantage is mainly the uncertainty associated with changes in rates and the fact that the effective rate is not known until the end of the settlement period. The SARON mortgage can be converted into a fixed-rate mortgage at any time.
In the current situation of uncertain interest rates, it may be advantageous to opt for a SARON mortgage while waiting for fixed rates to fall, if you are in a position to bear the uncertainties and fluctuations associated with market interest rates.
It may also be a good idea to split your mortgage to combine the advantages of different mortgage models (https://www.credit-suisse.com/ch/fr/articles/private-banking/hypothek-aufnehmen-so-kombinieren-sie-erste-und-zweite-hypothek-202104.html).
If you renew your mortgage, whether it’s a fixed or SARON mortgage, you can ask for your file to be updated. We advise you to do this only if your financial situation has changed for the better. This could result in a more favourable rate for you.
Repaying your mortgage?
If, in view of the recent rise in interest rates, you still wish to pay off your mortgage, you should be aware that if you subsequently wish to take out a new mortgage, you will have to submit a complete new loan application. What’s more, you will no longer be able to deduct the mortgage interest from your income on your (ordinary) tax return in Switzerland, while you will still have to pay the rental value, which is regarded as income.
If you are in any doubt about whether or not to keep your mortgage debt, we advise you to seek advice from a tax expert, who will be able to help you answer this question and determine your optimum level of indebtedness.
Against a backdrop of positive and rising interest rates, there are a number of factors to consider if you are thinking of taking out or extending a mortgage. Your decision will depend on your views on the trend in interest rates and your personal objectives regarding the property to be financed, i.e. do you want to keep the property or are you thinking of selling it in the near future? Finally, it will be important to choose a solution with which you feel comfortable. While some people will be prepared to accept variations in rates to aim for the best possible terms, others will be more comfortable if they can count on a stable budget over a defined period.
Brigitte Borel, 8.6.2023