If you're on the fence about whether to go with a fixed or variable rate loan, split rate loans let you have the best of both worlds.
What is a split home loan and how does it work?
A split home loan, as the name suggests, is a mortgage product that allows borrowers to divide their loan amount into two parts: one with a fixed interest rate and the other with a variable interest rate. This hybrid loan structure combines the stability of a fixed-rate mortgage with the flexibility of a variable-rate mortgage.
The ratio between the fixed and variable portions can usually be customised to suit the borrower's preferences and financial situation e.g. 50/50 or 70/30.
Let’s say you take out a $700,000 loan with a 30-year term and decide to split the loan 70/30. You fix $210,000 (30%) at 6.50% p.a. for a 3-year fixed period, and put the remaining $490,000 (70%) at a variable rate of 5.80% p.a.
Your monthly repayments would come to an approximate $4,202. This combines:
Fixed repayment: $1,327 per month
Variable repayment: $2,875 per month
Let’s say in 12 months' time, the market changes and your lender increases your variable rate to 6.25% p.a. Your monthly variable repayments would increase to $3,017, making your total monthly repayments $4,344.
Advantages of split home loans
Interest rate stability - One of the primary advantages of a split home loan is the security it provides. The fixed-rate portion ensures that borrowers know exactly what their monthly repayments will be for the fixed period, making budgeting easier and shielding them from rising interest rates.
Flexibility - Split home loans offer a degree of flexibility not found in traditional fixed-rate mortgages. Borrowers can take advantage of falling interest rates on the variable portion while still benefiting from the stability of the fixed portion. You might also be able to take advantage of other helpful features that are common among variable rate loans, such offset accounts and the ability to make extra repayments without penalty.
Peace of mind - For those who value financial predictability and don't want to constantly monitor interest rate trends, a split home loan offers peace of mind.
Disadvantages of split home loans
Complexity - Managing two loan accounts with different interest rates can be more complicated than handling a single mortgage. This complexity might not be suitable for everyone, especially first-time home buyers.
Penalties for breaking fixed rate - If borrowers decide to refinance, sell the property, or make significant extra repayments during the fixed period, they may incur break costs, which can be substantial and erode the benefits of a split loan.
Rate falls or rises - Successfully capitalising on a split loan's flexibility relies on predicting interest rate movements. If rates do not move as expected, borrowers may not fully realise the advantages of the variable portion - you could be exposed to the risk of rate increases. Additionally, if rates decrease, you won’t fully benefit from this on the fixed portion of the loan.
How do I decide if I should split my home loan?
The decision to split your home loan should be made after careful consideration of your financial situation, goals, and the prevailing economic conditions.
A split home loan may be suitable if you expect interest rates to rise in the future - splitting your loan can partially protect you.
If you’re looking for balance, a split home loan can give you stability and flexibility. For example, a fixed-rate might be ideal if you want predictable payments for a set period, while a variable rate can be beneficial if you want to take advantage of potential rate drops. Variable-rate loans also often allow for extra payments without penalties, which can help you pay off your loan faster and save on interest.