Home loans are likely fixed rate or variable rate. If you cannot seem to make up your mind between the two, a split loan may be what you’re searching for. With a split loan, you get the best of both worlds because it allows you to have a bit of both a variable rate loan and a fixed-rate loan.
So What Are They?
Let’s say that you borrowed $500,000. A split loan may allow you to lock 40% of the borrowed amount (equal to $200,000). Meanwhile, the remaining $300,000 (60%) of the loan is at a variable rate. Should interest rates rise, you don’t have to worry about the change for 40% of your loan. Meanwhile, if the rates decrease, the majority of your loan (60%) will benefit from it.
As you can see, a split loan lets you divide the money you borrowed (home loan principal) into portions with different interest rate types. You have your loan balance separated into two different accounts, where one is charged with a fixed rate and the other with a variable rate. You can split your loan 50/50, meaning 50% is a fixed rate while the other 50% is a variable rate.
Should the Loan Be Split Equally?
Split loans do not have to necessarily be split 50/50, although it is pretty much the standard in most banks. A broker can guide you in deciding the right split, which can be anything from 60/40 to 80/20. Some lenders may even allow you to split your loan several times, usually up to six times. Be sure to enquire about their split loan offers so you can determine the best one for you.
To truly benefit from a split loan, it’s vital to understand the terms of your lender to avoid any issues. Splitting your loan means that you distribute the movements of the interest rate, so there will always be risks, both for the variable rate and fixed rate portions. A mortgage broker will be able to help guide you to the best decision and lender based on the current market.
How to Split Your Loan
You can apply for a new home loan or split your existing one.
Here are the typical steps in getting a split loan:
- Find a lender that offers loans with a split facility. This step is crucial because not all mortgages allow being split, so be sure to check if the lender or a specific loan product supports splitting. If it does not, you can talk to the lender and request an exception. An alternative would be to refinance a loan that allows splits.
- For this next step, you will normally decide on this with the lender. Other financiers may have their calculations, so you have some options to consider. Splitting your loan will also depend on your loan structure. For example, you could split 50/50 or have more than two splits. You can find lenders that accept up to six divisions.
- Once your loan is approved, what usually follows is the repayment. Make sure that you repay your loan on time. Repayments for split loans are like traditional loans, although each repayment goes into each portion. If the variable part lets you make extra repayments, you may decide to put in more so you can pay off the loan faster.
- Ensure that you keep track of your rates, specifically the variable portion. You don’t have to monitor the fixed-rate part of your loan because the interest rate will not change during this period. However, it’s essential to remember that the variable portion can increase (or even decrease) at any time. Sometimes, the economic conditions may be undesirable, which can result in very high-interest rates. If it gets too high, it may be time to refinance your loan. Keep in mind that there are breaking costs or break fees (also known as the early repayment fee) for the fixed-rate portion of the loan, which can be extremely costly.
Before choosing to split your loan, it’s helpful to envision your future, such as in the next five years. Do you think you will still have the same job and salary? Will your needs change? Do you plan to raise a family or get married in the next five years? Even if you are unsure, you should have a tentative answer to these questions. It will help you select the right loan, whether it’s split or not.
Remember that a split loan is included in your loan package, so it’s not a separate loan on its own. It can surely get confusing, so you should speak with your lender and broker to get all the details you require to make your final decision.
Let us say that you have borrowed $500,000, which you will pay the principal and interest monthly for the next 30 years. The fixed interest rate is 3% and will run for five years, and the variable interest rate will, of course, change.
Here’s what it will look like for a 60/40 split:
- Monthly repayments will amount to $2,132 for the next five years for the fixed period.
- Total interest for the whole loan term is $271,852 for a variable rate of 3.15% per annum.
In a 70/30 split:
- Repayments for the five-year fixed period will be $2,136 per month.
- The total interest payable for the whole duration of the loan will be $272,271.
In an 80/20 split:
- Monthly repayments will be $2,141 for the five-year fixed period.
- The total interest payable for 30 years will be $272,689.
If the variable rate changes, your monthly repayments will increase, along with the total interest payable. So, taking the same example above, but this time with a 3.50% variable interest rate, the monthly repayments will be $2,190 for the five-year fixed period. Meanwhile, the total interest payable for the next 30 years will be $302,612.
Again, there is no definitive rule on how you split your loan. The decision is up to you and the lender. However, you must consider your financial circumstances, not just for the present but shortly as well. You should also ask yourself whether you prefer short-term stability in your home loan and whether you would like to take advantage of certain features, such as redraw facilities and offset accounts.
How Can Splitting Your Loan Help You?
The main benefit of split home loans is that you have both types of interest rates. You could potentially reap the rewards of a low-interest-rate environment with your variable rate. That’s because your interest rate will fall, which will not happen if you only have a fixed-rate home loan. And even if the interest rates rise, you do not have to worry that much if the bigger part of your loan is fixed.
Benefits of the Fixed Portion of the Loan
- You can lock in your home loan for a specific period, such as one year, three years, or five years.
- The fixed period means that the interest rate will stay the same no matter the changes in the country’s official cash rate.
Please note that after the fixed portion of the loan ends, the interest rate will revert to a variable rate. If you think that the rates have the potential to rise in the coming years, it’s best to choose the longest period available.
Benefits of the Variable Portion of the Loan
Remember that the variable-rate can differ from one lender to the next. That’s because the rate is determined by the bank standard variable rate (BVSR), meaning the bank or lender itself. A 30-year loan of $300,000 with a variable rate of 4.5% means that you pay $1,520 monthly. However, if the interest rates rise by 2%, meaning your variable rate will now be 6.5%, you will have to adjust your monthly repayments to $1,847. That’s an increase of more than $300.
The variable portion shouldn’t scare you away from a split loan. Here’s why:
- It makes the loan flexible, particularly if you are interested in making unlimited extra repayments. That’s beneficial because you can pay off the loan faster, which means you can become debt-free in less than 30 years.
- You can also get an offset account, allowing you to offset a portion of your monthly interest.
- If the rates drop, you pay less on interest for the next few years.
As a whole, a split loan lets you benefit from falling interest rates while also cushioning the impact of interest rate hikes, thanks to the fixed portion of the loan. Another huge benefit is that a split loan can be adjusted to your preferences. The standard is a 50/50 split, but you always have a lot of options. Be sure to talk to the lender to know your available choices.
If you prefer security with a little bit of flexibility, you can have the split loan divided in favour of a fixed rate. However, if you want to take advantage of an offset account, you can split the loan in favour of the variable portion. An offset account will be linked to your loan. Any money you deposit into this account will “offset” your loan, so you pay less interest. Additionally, you shave time off the life of the split mortgage loan.
What to Be Wary of
A split loan does have many attractive benefits. However, there are also potential downsides, especially if you do not know what you are dealing with. You can avoid these pitfalls if you have a professional who will help you decide on the type of loan to go for.
Here are the drawbacks that you should be aware of if you ever split your loan:
- If the interest rates rise, you will still be affected. You may have a fixed rate portion, but the current high rate will still be applied to the variable portion. That means larger repayments.
- The fixed period rate is not forever. Usually, the maximum period is five years. Once it’s finished, your monthly repayments will likely increase at this point. That’s why having a broker will help you determine whether to fix your rate again or continue with a variable rate.
- Breaking your fixed-rate loan can incur hefty break fees.
You can avoid the break fee by paying or refinancing your loan after the fixed-rate period.
Should You Split Your Loan?
A split loan is suitable for almost everyone, particularly those who may be worried about the interest rate cycle at this moment in time. If you do not trust the economic conditions and you foresee that there will be an interest rate hike in the future, a split loan may be a good option. It gives you protection against any interest rate increases, which a variable rate home loan will not provide for you. While you can always go for a fixed-rate home loan, you may also want to take advantage of the possible decrease in interest rates. You cannot get this benefit if you choose a fixed-rate loan.
For flexibility and security, a split home loan may be your best bet. Also, don’t forget that variable home loans offer additional features, such as early repayments and an offset account which will let you save on interest charges. The fixed-rate portion of your home loan provides security and planning since you know exactly how much you will pay each month. You can then budget your finances accordingly.
Can’t Decide? Let Us Help!
As your broker, we can help you design a split loan that truly works for you and your financial situation. We understand that calculating splits and determining how this type of loan can be useful to the average borrower can get frustrating. And that’s why we’re here. We want to guide you in making a decision that will be beneficial for you, not just today but in the future, too. Talk to one of our professional brokers so you can get advice on whether a split loan is for you or another type of home loan that will benefit you more.