As house prices have soared, Australians have taken on ever more debt to get onto and up the property ladder. Of course larger mortgages mean hefty interest payments – so it’s important to think carefully about how you structure your loan to manage your finances.
For many, a split mortgage is an attractive option; it allows the borrower to segment their home loan into smaller parts that are subject to different repayment criteria. This means that they can access the benefits of both fixed and variable rate mortgages on their loan.
A split rate home loan is not a product itself. Rather it’s a feature on a home loan package that a lender may offer. Lenders allow you to carve up your mortgage how you like – it does not have to be a 50/50 split between fixed and variable rates. This gives you better control over how you manage your day-to-day expenses and mortgage repayments.
With a fixed rate loan you pay a set interest rate on your home loan for a designated period of time. This is usually one, three or five years, depending on your lender. When the term ends, the loan switches to the lender’s variable rate, unless you negotiate a new fixed rate.
The main advantage of a fixed rate loan is that it provides the borrower certainty of how much they will pay for that term. It gives many peace of mind knowing they can afford their repayments (notwithstanding any changes in personal circumstances).
Many fixed rate loans also allow you to make some additional payments. This amount cannot be withdrawn again so it is safely locked away in your mortgage, helping you pay down your debt.
The fixed nature of this loan, however, means that you cannot pay it off early without incurring penalty fees; you cannot make extra payments beyond those allowed in the terms of your loan agreement. In some situations though, you may want to pay out your loan early – such as if you want to sell your home or refinance your home loan. In this case you would be subject to exit fees, which can be costly.
Another disadvantage of a fixed rate loan is that you may be locked into an interest rate at a time when rates drop. Likewise if rates are expected to rise, this will be already factored into the rate available to you.
Each lender has a standard variable interest rate that they apply to home loans. This is influenced by the RBA’s cash rate and what their competitors are offering. With this type of loan your repayments increase when interest rates rise, and decrease when interest rates fall.
The main advantage of a variable rate loan is that it offers flexibility, particularly in relation to making extra repayments. If rates fall so will your monthly repayment, but if you carry on paying what you can afford you will pay your loan off quicker.
Variable rate loans also come with more product features that can help you better manage your finances. For example, you may be able to redraw any additional payments you make as required.
Likewise an offset account may be available to you. This means that you can use your savings to offset the principal of the loan. So if you have a mortgage of $500,000 and $10,000 in savings, you would pay interest on $490,000. This means that you would pay less interest over time and get your loan paid off quicker.
Furthermore without costly exit fees it is cheaper to refinance a variable rate mortgage than a fixed rate one if you find a better deal elsewhere.
The key disadvantage of a variable rate mortgage is that you will pay more – and may experience financial stress – in an environment of rising interest rates. It is for this reason that many choose to fix a portion of their loan.
A split mortgage offers both flexibility and security in your home loan and helps you take better control over your financial affairs.
You may, however, pay more in fees for a more complex home loan product – but the ability to pay off your mortgage faster could make this well worthwhile.
A split mortgage also requires better management than a basic home loan product. You will need to stay on top of any changes your lender makes to interest rates, so you can adjust how you repay accordingly.
Speak to a home loan expert before you apply for a split mortgage loan feature. They will provide more information that will help you manage the risk associated with each loan type. They can also help you decide what split portions are right for you.