Thriving housing market threatens debt trap

Home construction has been booming with low interest rates on tap Keystone

The ticking economic and social time bomb of mortgage debt needs defusing before it explodes, a government appointed taskforce has warned.

Swiss households took on SFr28 billion in additional loans in 2010 to bring the total pot to SFr632 billion ($690 billion). Concerns centre on lax lending standards and a tax quirk that discourages people from paying off debt.

In addition to approving a previous recommendation to crack down on mortgage lenders, the taskforce urged the government to scrap the contentious homeowners tax. “Household indebtedness is essentially promoted by the state,” the taskforce summarised.

The International Monetary Fund (IMF) endorsed the suggestions in its annual evaluation of the Swiss economy, presented on Tuesday (see box right).

In stark contrast to many other developed economies, Switzerland’s housing market has gone from strength to strength despite the financial crash and subsequent recession.

Boosted by low interest rates and a continued influx of highly skilled foreign workers, the price of a single family home rose 6.4 per cent last year and 8.6 per cent for an apartment.

“As a result of the high degree of indebtedness, households are strongly exposed to certain risks, such as a sharp rise in interest rates,” the government taskforce stated last week.

Some 17 per cent of households would not be able to afford repayments if rock bottom interest rates rose by three per cent, according to a survey by price comparison website Comparis.

“State promoted” debt

The taskforce recommended a crackdown on lending practices that would compel banks to look more closely at default risks. It also called for banks to be forced to hold specific countercyclical capital buffers to compensate for potential losses.

Another recommendation was the abolition of the home ownership levy that charges income tax on the rental value of properties even if they are not actually being rented out. Owners can offset mortgage interest payments, the cost of home improvements and energy saving enhancements against this tax.

The net result is that homeowners are discouraged from paying off their mortgage debt for fear of incurring a larger tax bill.

Another quirk in the tax system allows homeowners to use part of their pension pot to fund the purchase of homes, even signing over their retirement savings as collateral to mortgage lenders. UBS bank estimates that SFr2.6 billion ($2.8 billion) disappears from pension plans every year for this purpose.  

The Swiss Homeowners Association has long campaigned for the abolition of a tax system that artificially keeps households in debt. But despite widespread dissatisfaction with the rules, several efforts to change the system have foundered.

Powerful lobbyists

Part of the reason is that such initiatives have previously been rolled up into wide ranging tax reform proposals that have failed to pass through parliament.

Opposition has also come from the influential renters association. The construction industry is also opposed to abolishing tax breaks for property renovation while environmental groups want to keep incentives for energy efficient homes.

Only 40 per cent of Swiss households own their own property, but the rate of homeownership has been steadily rising in the past 20 years.

“This has resulted a greater social acceptance of home ownership which used to be viewed as the preserve of the rich,” Pavlo Stathakis, legal counsel at the Homeowners Association told swissinfo.ch. “As a result, the imputed rental tax is growing more and more obsolete.”

Swiss voters will get a chance this year to decide on an initiative that would allow pensioners to opt out of paying homeownership taxes in exchange for losing the offsetting tax breaks.

Hotspots glowing

Stathakis poured scorn on the government taskforce’s findings, particularly in light of both the cabinet and parliament recently rejecting the association’s initiative to weaken the homeownership tax.

“They act as if they have just discovered that homeowners are highly indebted in Switzerland, but this has been well known for years,” he told swissinfo.ch.

While politicians and lobby groups debate the merits of the tax system and mortgage lending standards, property prices continue to rise dangerously in certain areas. A collapse in prices could also throw the market into disarray if owners find themselves in negative equity.

The hotspots of Geneva, Zurich and tourist destinations such as St Moritz continue to concern observers. Prices for homes are outstripping income gains by up to 20 per cent in the most sought after locations.

Credit Suisse bank estimated that prices in 38 of 106 regions are now unsustainable in its latest real estate report.

But appetite for property continues to grow. Nearly 46,000 net new homes were built in 2011, an 11.5 per cent increase on the previous year and the biggest construction boom since 1995. The net number of new homes this year is expected to be even higher.

Key facts:

Some 40% of Swiss households own their own property, up from 31% in 1990 and 37% in 2008.

This is comparable to Germany but well below most other most other OECD countries, where the rate is well above 50%.

The amount of wealth tied up in Swiss property by the end of 2010 was SFr1.4 trillion. This was an increase of SFr55 billion from 2009, mostly attributable to the rising value of properties.

An apartment typically cost SFr564,000 in 2005, but will now set buyers back SFr844,000, according to real estate specialists Wuest & Partner.

The asking price for an “average” single family homes has risen from SFr855,000 to SFr1,134,000.

The cost of owning a property has fallen in comparison to renting thanks to rock bottom interest rates. Owning a property eats up 21% of a family budget in a single family dwelling and just 17% in a flat compared with 22% for renting an apartment.

History beckons?

Switzerland suffered a major housing crash in the early 1990s that cost people their homes and banks SFr42 billion in defaults.

Since then, mortgage lending standards were tightened, but the Swiss National Bank and the Swiss Financial Market Supervisory Authority have repeatedly expressed concerns in recent years about a return of complacency.

The International Monetary Fund (IMF) waded into the debate during a ten-day  visit to evaluate the Swiss economy: “There are signs of overheating in some hotspots and market segments, as well as evidence of loose mortgage lending policies,” the IMF said in statement.

The head of the IMF delegation Enrica Detragiache welcomed all the government workforce recommendations, including an abolition of the homeowner’s tax. “It would basically remove a distortion that has very little reason to exist in our view,” she told reporters.

She also said proposals to reign in mortgage lending standards could even go further to take into account affordability factors.