Does splitting a loan provide the best of both worlds?
One of the major decisions a borrower will have to make is whether to go for a variable rate loan or a loan with a fixed interest rate. But why choose one when you can have both?
There are many different loans available to property buyers, each with different features and advantages, which can make choosing a loan a difficult process. One of the major decisions a borrower will have to make is whether to go for a variable rate loan or a loan with a fixed interest rate. But why choose one when you can have both?
There are many borrowers who are opting to split their loans into two accounts, one on a variable rate and one on a fixed rate. Loans can be split in many ways dependent on the needs of the borrower, such as 60% variable and 40% fixed, but 50/50 splits are most common.
The reason for splitting a loan is to provide the security of a fixed rate home loan with the added flexibility of a variable rate loan. It’s a form of hedging that may be useful in times of economic uncertainty, particularly when interest rates are rising. Someone with a split loan will be less impacted by rate rises as it will only affect a portion of their loan. However, by maintaining a portion of the loan with a variable rate means the borrower still benefits from rate reductions.
Another benefit of a split loan over, say, a 100% fixed loan, is that the borrower still has the flexibility of a variable loan, such as the ability to make additional repayments and redraw (on the variable part). These features aren’t typically available on a fixed loan but can be very useful as the circumstances of the borrower change.
So what are the disadvantages of a split loan? The nature of a split loan means that the borrower, though protected partly from rate increases, doesn’t benefit fully from a rate reduction. This can prove quite costly if rates drop significantly during the term of the fixed portion of the loan.
Also, splitting a loan may incur twice the fees for setting up, managing and later discharging the loan, which borrowers should consider. Clearly, there are a few things to consider when deciding whether to split or not.
As everyone’s situation is different and loans have many subtle differences, the advice of a professional, qualified finance broker should always be sought before making any borrowing decisions.