Direct or indirect amortization: which is the best method to repay your loan?
When you take out a mortgage to buy a property, you need to think about amortizing it, that is, gradually repaying the borrowed principal. In Switzerland, two main methods exist: direct amortization and indirect amortization. Not sure which to choose? We explain everything simply.
What is mortgage amortization?
When you buy a property in Switzerland, the bank usually does not finance 100% of the purchase price. As a general rule:
- You must bring at least 20% of equity (savings, 2nd pillar, etc.)
- The bank grants you a first-rank mortgage, covering about 65% of the property price.
- If you need additional financing, you will have to take out a second-rank mortgage
What is the difference between first and second rank?
The first-rank mortgage can remain in place without any repayment obligation as long as you pay the interest. No amortization is required as long as the debt remains within the authorized limit. The second-rank mortgage, however, must be repaid (amortized).
Within what time frame must a second-rank mortgage be amortized?
Amortization of the second-rank mortgage is generally required over a period of 15 years, or at the latest until the legal retirement age (64 years for women, 65 years for men). This means you must plan for a regular repayment schedule (usually yearly) for this portion of the loan.
Example:
You want to buy a property valued at 800,000 CHF. Here is how real estate financing is generally structured in Switzerland:
- Equity: you must provide at least 20% of the purchase price, i.e. 160,000 CHF. This amount can come from your savings, your 2nd pillar (under conditions), or an inheritance, for example.
- First-rank mortgage: the bank finances about 65% of the property price, i.e. 520,000 CHF. This part of the loan does not need to be amortized (repaid) as long as you do not exceed this limit. You only pay the interest.
- Second-rank mortgage: you still lack 15%, i.e. 120,000 CHF, which the bank agrees to lend you as well. This portion constitutes the second-rank mortgage, and it must be amortized, i.e. repaid over a maximum period of 15 years or before the legal retirement age (whichever comes first).
This repayment can be done:
- Either by direct amortization: you repay part of this 120,000 CHF each year
- Or by indirect amortization: you invest each year an equivalent amount in a pillar 3a or insurance, which will be used to repay the loan at maturity
What is direct amortization?
Direct amortization is the most intuitive method: you repay part of the principal of your loan each year.
Advantages:
- the amount of your debt decreases
- the interest paid each year also decreases
- your overall financial burden gradually decreases
Example:
You have a mortgage loan of 600,000 CHF. If you amortize it by 10,000 CHF per year (direct amortization), then:
- the second year, you only pay interest on 590,000 CHF
- and so on
What is indirect amortization?
With indirect amortization, you do not immediately repay the principal to the bank. Instead, you pay each year an equivalent amount into a linked pension policy (pillar 3a or life insurance). At maturity, this accumulated sum will be used to repay the loan in one lump sum (fully or partially).
Advantages of indirect amortization
- Tax advantage: payments into a pillar 3a or life insurance are deductible from taxable income, which reduces your taxes each year. And higher mortgage interest leads to a stronger tax deduction: since you do not repay the principal, the amount of interest remains stable and 100% deductible from taxes (unlike direct amortization where interest decreases over time).
- Retirement preparation: the funds paid into a pillar 3a constitute private savings, useful to supplement your income in the long term.
Disadvantages of indirect amortization
- The debt remains constant: unlike direct amortization, you do not reduce your debt before maturity.
- Risk related to the savings product: if you invest in a pillar 3a linked to equity funds, the performance is not guaranteed. You could accumulate less than expected.
- Less flexibility: amounts paid into a pillar 3a are blocked until retirement or loan repayment. No free withdrawals.
How to choose between direct and indirect amortization?
Here are some criteria to consider when making your choice:
| Criteria | Direct Amortization | Indirect Amortization |
|---|---|---|
| Reduce debt | Fast | Deferred |
| Tax optimization | Limited | More tax advantageous |
| Need for flexibility | Free repayment | Blocked payments |
| Investment horizon | Short term | Long term (retirement preparation) |
How to amortize your mortgage while saving money?
Amortizing a mortgage is not just about repaying your debt: it is also an opportunity to optimize your taxes and manage your assets smartly. Here are some tips to combine amortization and savings.
Choose indirect amortization to maximize tax deductions
By placing your repayments in a pillar 3a, you can deduct up to CHF 7,056 per year (2025 ceiling) from your taxable income. This reduces your tax burden, while preparing your retirement or final repayment.
Maintain a stable debt level to maximize deductible interest
With indirect amortization, you keep a high debt longer. This may seem counterintuitive, but as we saw, mortgage interest is deductible from your taxes. Result: less capital repaid = more deductible interest.
Compare the performance of 3a products
Not all pillar 3a products are equal:
- The bank pillar 3a is secure but low-yielding
- The pillar 3a with funds is riskier but offers better potential returns over the long term
Choose a product suited to your investment horizon and your risk tolerance.
Do not overlook fees
Some insurance products linked to indirect amortization include high fees (management, early redemption, etc.). Be sure to compare actual costs to avoid losing the tax advantage.
Simulate both scenarios
Before choosing, run a mortgage simulation:
- With direct amortization
- With indirect amortization and tax deductions
The right choice depends on your income, family situation, canton of residence, and long-term goals. You will quickly see which solution is the most advantageous in your personal case.
Concrete example: direct vs indirect amortization
Let’s imagine you borrow 500,000 CHF with an interest rate of 1.5%.
With direct amortization, you repay 10,000 CHF of principal to the bank each year. Your debt gradually decreases because you pay interest on 490,000 CHF the 2nd year, then 480,000 CHF, etc. The only downside: you have less interest to deduct from your taxes.
With indirect amortization, you don’t repay the bank immediately. Instead, you contribute 10,000 CHF/year into a pillar 3a (or a related pension product). Your debt remains the same (500,000 CHF) throughout the period. You continue paying 7,500 CHF in interest each year, but you can deduct both the 7,500 CHF interest and the 10,000 CHF paid into the 3a from your taxable income.
Common mistakes to avoid
- Believing indirect amortization is “free”: it costs, but differently
- Forgetting fees related to managing a pension product
- Not adapting the amortization choice to your tax or asset situation
- Not comparing the actual performance of indirect amortization (some contracts are not very profitable)
By following our advice, you will move into your new home more quickly.
Frequently asked questions about direct and indirect amortization
What is the main difference between direct and indirect amortization?
Direct amortization consists of repaying the loan principal each year, whereas indirect amortization consists of placing the equivalent amount into a savings product (pillar 3a or insurance), used to repay the loan later.
What are the tax advantages of indirect amortization?
Amounts paid into pillar 3a are deductible from taxable income, just like mortgage interest. This significantly optimizes your tax burden.
Can I change amortization method during the loan?
Yes, but it depends on conditions set by your bank. Some allow the transition under certain conditions. It is recommended to consult your advisor before modifying the structure.
Is indirect amortization risky?
Not necessarily, but it depends on the chosen vehicle (classic savings or investment funds). Poor performance of the pillar 3a could result in insufficient capital to repay the loan at maturity.
Which products to use for indirect amortization?
The most common are:
- The bank pillar 3a (secure savings account)
- The pillar 3a with investment funds (riskier but potentially more profitable)
- Life insurance linked to pension plans
All these products are locked until retirement or repayment and offer interesting tax advantages.
Which amortization solution is best for me?
It all depends on your goals:
- If you want to reduce your debt quickly, choose direct amortization
- If you want to optimize your taxes or prepare for retirement, opt for indirect amortization
Need help choosing the right strategy?
Are you hesitating between direct and indirect amortization for your mortgage loan? Our experts are available to analyze your personal situation, simulate potential tax savings, and help you make the right decision.
Contact us now for personalized support!
