When to use a split mortgage

By Geraldine Grones

In recent years, low home loan rates and climbing property values have convinced many people to buy a home – be it for owner-occupied or investment purposes. Perhaps you are one of those people and now, you are searching for a home loan which will enable you to purchase the property you have always wanted.

But what if you are torn between fixed rate and variable rate home loans? Don't fret, a split mortgage may be the solution to your problem.

First of all, what is a split mortgage?
A split mortgage is a loan feature that enables you to split your home loan into multiple accounts that attract different interest rates. You can allocate as much as you want to each account as long as it is allowed by your lender.

A split mortgage has two components: fixed rate and variable rate.

A fixed rate enables you to lock in your home loan for a certain period of time, usually one to five years. During the fixed period, the interest rate on your loan will remain the same, despite any RBA changes to the official cash rate. When the fixed term ends, the interest rate reverts back to a variable rate.

Meanwhile, the variable component of a split mortgage will be set to the bank standard variable rate (BSVR). The interest rate that will be charged to you varies according to the RBA cash rate.

A split mortgage allows you to manage the risk of interest rate fluctuations effectively in times of economic uncertainty with its fixed component and, at the same time, take advantage of depreciating rates with the variable component.

Before we go further in discussing split mortgage, we should first delve deeper into its two components.

What are the differences between fixed and variable rate mortgage?
With a fixed rate mortgage, you will have fixed repayments during your chosen fixed term, which enables you to make budgeting much easier. Also, you can enjoy reduced costs when interest rates fall. For some fixed loans, you will also have the ability to make extra repayments up to a certain amount, as well as enjoy a redraw facility.

However, this type of mortgage also has its downsides. There may be times that your fixed rate is higher than the market rate – and the only way to benefit from the lower market rate is to go through the hassle and expense of refinancing. Also, the size of your repayments can be higher than needed while your repayment flexibility can be reduced. Aside from these, there can be costly penalties if you want to change your lender or break your fixed loan term early.

Meanwhile, with a variable rate mortgage, you can make extra repayments to help pay off your loan faster. For instance, if interest rates fall but you discipline yourself to keep paying the same amount as before, you can potentially cut years off your loan and save thousands of dollars. Also, if the RBA cuts the cash rate, you might get a reduction on your interest rate as well. Aside from these, it may also be easier to switch loans if you find a better deal as you are not locked in the same way as when you have a fixed home loan. Despite these benefits, a variable loan can be also risky. When interest rates rise, you will need to be prepared to make higher repayments.

After looking at the benefits and risks of both fixed and variable rate mortgages, we should now look at the benefits and risks of their combined version – split mortgage.

What are the advantages of a split mortgage?
By splitting your home loan, you can enjoy the benefits of both fixed and variable rates while reducing the risks on each option. A split mortgage particularly offers the following benefits:

  • Security: The fixed component of the loan lets you manage the risk of interest rate fluctuations, protecting you from sudden interest rate rise.
  • Flexibility: Though more risky than the fixed component, the variable component of the loan allows you to take advantage of potential interest rate fall.
  • Competitive rates: You can enjoy a competitive interest rate which can be secured with the fixed rate while retaining the flexibility of the variable component.
  • Unlimited repayment option: You can make unlimited extra repayments on the variable component of the loan, allowing you to reduce the size of loan much quickly.
  • Offset: Some lenders can give you an option to have an offset account, which can help you save a lot of money on interest.
  • Increased savings: The fixed component of the loan can help you save more when interest rates rise. What are the disadvantages of a split mortgage? Despite having many benefits, a split mortgage can also be risky. Here are its potential downsides:
  • Missed rate reduction: You might miss out on the potential interest rate fall on the fixed component of the loan.
  • Increased repayments: Since a portion of the loan is variable, you might pay more if interest rates rise.
  • Greater funding: You might need more funds to cover the variable component of the loan if interest rates rise.
  • Break fees: The fixed component of the loan may attract break fees if you wish to pay it out.
  • Additional fees: You might attract added establishment and ongoing fees that may be charged on both the fixed and variable components of your loan.

Now that you know the pros and cons of a split mortgage, it is time to know when to use it.

When should you use a split mortgage?
A split mortgage is suitable for you if:

  • You are not sure about how the interest rate cycle is doing
  • You are looking for both security and flexibility in a loan

However, before deciding to split your loan, it is recommended that you seek professional advice from your accountant or financial advisor to help you assess your current situation.

If you indeed go for a split mortgage, keep in mind that it is not a separate loan in itself – it is only a feature that is included in a loan package. To be able to enjoy this feature, speak with your lender or credit provider if this can be included in your loan package when you apply for a particular home loan product.

There is no such thing as the best split mortgage because, again, it is not a standalone mortgage option. But when you opt for a split mortgage as part of a loan package, here are some things that you should consider looking for:

  • Benefit from other features: Consider whether the other features included in the loan package are worth the additional costs.
  • Low or no setup fees: Some lenders will charge you each time you split your loan. If a fee–free split option is not possible, find a split loan with affordable fees.
  • No penalties for additional repayments: Although your home loan has a variable component, remember that it also has a fixed component. As such, you may get charged when you make additional repayments towards your loan. So, you should find out whether you can only make repayments to the variable component of the loan or you can avoid additional repayment fees altogether.
  • Ability to choose the length of the split term: As with other fixed rate terms, you can choose the length of time your loan is split into fixed and variable rates. However, this ability will depend on your lender and loan package.
  • Ability to customise your split: There is no general rule when it comes to how much you can split your loan. It means you can split by any amount you want. For instance, you can opt for 80:20, 60:40 or 50:50 – whichever may be the most suitable for you. Some lenders will even allow you to split your loan up to four times, giving you plenty of room to customise your rate structure to suits your needs.
  • Guarantor option: With the help of a guarantor, lenders will allow you to borrow up to 100% LVR, some even up to 105% to cover additional costs such as government stamp duty. Most lenders will even waive the LMI requirement if you have a guarantor. In a previous article, we have listed everything you need to know about guarantor loans.

No mortgage is risk-proof – as every mortgage out there has its own set of risks. But a split loan option might be a great way to avoid some of the pitfalls of the mortgage and property market. It can also be a very savvy way to get the most out of your mortgage, especially when interest rate cuts are likely to happen.

If you need help in deciding whether to use a split mortgage or not, speak with an accredited mortgage broker or compare the different home loan products available on Your Mortgage to help you choose the right option for your needs.

 

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