With the RBA keeping interest rates at a all-time low of 1.50% for 18 consecutive months, we are currently living in an environment where the interest rate on your home loan could spike when you least expect it.
This, coupled with the news that 2 in 5 borrowers are being hit with a range of discreet rate and fee increases in response to rising lender funding and compliance costs, probably has you feeling a little jittery.
If you are anything like me, you already have more than enough on your plate to worry about! The last thing you want to stress about is your mortgage repayments going up and adversely affecting your family’s lifestyle.
So what can you do about it? Well, most lenders offer fixed rate options, such as fixing your interest rate for 1 to 5 years, or 1 to 3 years, which tends to be the most attractive option for many homeowners.
However, a fixed interest rate product often doesn’t give you the flexibility that a variable rate product does, such as the ability to make unlimited extra repayments or access to an offset account. If you are looking for flexibility and, at the same time, seeking to minimise the risk of your repayments going above a level you’re comfortable with, then splitting your loan into part fixed and part variable portions may help you achieve just that.
What is a split loan?
A split loan is simply borrowing the loan amount in parts. You could, for example, put some of the loan on a fixed interest rate and the rest on a variable interest rate. Sometimes the lender may refer to this as a ‘combo’ loan, where you are effectively using two products, fixed rate and variable rate, to make up your total borrowing.
In most cases, you can choose to apportion your split however you like (subject to the product’s minimum loan amount). For example, you could opt for a 10% fixed rate with a 90% variable rate; or 50% fixed and 50% variable. If you are looking to borrow $500,000 in total, splitting 50% fixed and 50% variable would mean you are borrowing $250,000 on the fixed rate product and $250,000 on the variable rate product.
What motivates someone to split their home loan in such a way? Well, did you know that splitting your home loan could help you manage risk?
Most people who choose to split their home loan do so to hedge interest rate risk, which means mitigating the risk your repayment will increase, as well as the interest you pay on the loan. Here are two comparable scenarios that illustrate the effect on monthly repayments if the interest rate increases by 1%:
A loan amount of $500,000, repaying monthly over 30 years.
|$500,000 on a Variable Rate @ 4% p.a.||$250,000 Variable Rate @ 4% p.a.
$250,000 on 3 year Fixed Rate @ 4.2% p.a.
|(P&I) Monthly Repayment||$2,387.08||$2,416.08|
|Interest rate increase by 1%||$500,000 on a Variable Rate @ 5% p.a.||$250,000 Variable Rate @ 5% p.a.
$250,000 3 year Fixed Rate @ 4.2% p.a.
|(P&I) Monthly Repayment||$2,684.11||$2,564.60|
|Difference||+ $297.03||+ $148.52|
An increase of 1% on the variable interest rate equates to an additional $297.03 per month in repayments when the whole amount is on a variable rate, compared to $148.52 when fixing half of the loan on a fixed interest rate.
You’re probably wondering then, why not just fix the whole loan amount?
Making extra repayments
Fixed interest rate products often have restrictions on the amount of extra repayments you can make per year or during the fixed rate period without incurring a penalty (often known as a ‘break cost’ or ‘prepayment fee’).
The amount allowable will vary from lender to lender but, generally, a fixed rate product will allow you to make up to $10,000 per year without penalty. That means fixing your whole loan may restrict you in only making up to $192.30 each week in extra repayments. The table below will give you an idea of the allowable additional repayments on a $500,000 loan:
|100% fixed||90% fixed|
|Allowable extra repayment for the first year||$10,000||$60,000||$110,000||$460,000|
*Mortgage Fact: Did you know you can nominate to split your loan in other proportions (besides 50/50) and each combination will have a different interest cost, repayment sensitivity, etc.?
If you are intending to add an additional $1500 to your minimum monthly repayments (or $18,000 in extra repayments per year), then fixing 100% of your loan will not give you that flexibility.
Features available on a variable loan that are not available on fixed
Although there are lenders that will offer greater flexibility on their fixed rate products, most of the time there are only partial or no offset facilities available – as well as restrictions on the amount of extra repayments you can make and the amount of surplus funds you can redraw. Therefore, splitting your loan into fixed and variable repayments may allow you to enjoy the best of both worlds.
To conclude, splitting your loan into part fixed, part variable is a great way to lower the risk of exposure to an increase in your repayments due to an interest rate rise. At the same time, it enables you to access the features offered by the variable rate product.
On the other hand, having a split loan can also be beneficial in the event of interest rates dropping. If you have a fixed rate and interest rates fall, you are locked into your rate and simply cannot capitalise on the option to make less in repayments.
However, if part of your loan is variable, then you can still benefit from the decrease in interest rate on the variable portion, paying less in repayments and interest.
So, the next time you’re wondering whether to get a Fixed or Variable rate loan, combining the two may be the answer you’ve been looking for.