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Split loans: the best of both worlds?

Wednesday, 17th Oct 2018
Categories: Finance, Newsletter

One of the key decisions investors will need to make when purchasing a property and applying for a new loan is whether to opt for a fixed or variable interest rate. However, an alternative option that property investors sometimes take when seeking to reduce their risk or capitalise on the benefits of both options is splitting their loan into separate components.

As the name suggests, split loans allow investors to separate their loan into different loan accounts, with most investors typically opting to fix interest rates on one portion of the loan whilst leaving the other component variable. So what are the potential benefits of this strategy?

The benefits of split loans

Split loans

Security – Whilst the fixed portion of the loan allows investors to manage the risk of increases to interest rates, the variable component of the loan also enables them to take advantage of rate cuts should interest rates with their lender actually decrease. This can be particularly useful in times of economic uncertainty or volatility in the lending environment, as it allows investors to minimise the impact of rate fluctuations that work against their favour.

Flexibility with repayments – One of the drawbacks of opting for a fixed loan over a variable interest rate is the reduced flexibility this gives investors when it comes to making additional repayments. Many lenders will limit the number of extra repayments you can make on fixed rate loans, which can be a problem for investors looking to pay off their loan faster. By opting for a split loan, investors will have the flexibility to make additional repayments on the variable component, which can be an ideal solution for investors looking to be more effective with their repayments without fully compromising the stability of a consistent interest rate.

Additional features – By having a variable component in their loan, investors may also be able take advantage of additional features such as offset accounts and redraw facilities to help them better manage their mortgage repayments and pay their loan down faster. These features often aren’t accessible for investors with a loan that is fully fixed.

The drawback of split loans

Before applying for a split mortgage, it’s also important to understand the implications and potential drawbacks of splitting your loan. For example, if interest rates were to rise but part of your loan remained variable, you would be partially impacted by the fluctuations and would miss out on the potential savings you could have made by fixing your entire loan. Similarly, if interest rates decreased and part of your loan was fixed, you also wouldn’t be able to take full advantage of the lower rates available through the variable component. The case study below demonstrates how this scenario could work.

Case study – As an example, a borrower takes out a $400,000 loan over a 30-year term. They fix three quarters of the loan at 3.95% for two years, keeping the remaining $100,000 variable at 3.80%. In this scenario, their fixed monthly repayments would be $1,423 per month, and their variable repayments would be $465 per month, bringing their total monthly repayments to $1888.

If the lender were to increase their variable rate by 20 basis points to 4%, the borrower’s total monthly repayments would increase to $1,900, marking an increase of $12 per month. In this instance, if the borrower had opted to make the entire loan variable rather than split the loan, their total monthly repayments would have increased from $1, 863 to $1,909, marking a higher increase of $46 per month.  

If, on the other hand, the variable rate was actually to decrease by 20 basis points to 3.60%, the total repayments in the split loan scenario would decrease to $1,877, saving the investor $11 per month. In this case, if the whole loan was variable, the repayments would have decreased to $1,818 per month. Whilst the variable loan would have provided the investor with the lowest repayments in this situation, this scenario is wholly dependent on interest rates decreasing, which is extremely hard to predict as an investor.

Choosing the right option

Deciding whether a split loan is suitable in any given scenario will ultimately depend on your needs and objectives as an investor. Before deciding which option to take, it’s important to speak to a professional mortgage broker who can help you understand the potential risks and benefits of each option to ensure you’re making the best decision for your individual situation.

If you’re applying for a property loan and would like professional advice on the best option for your circumstances, our finance brokers would be happy to discuss your needs in an obligation-free consultation.