Split Loans Explained: A Balanced Approach to Managing Rate Fluctuations

Managing a home loan can be challenging, especially when interest rates are fluctuating. Borrowers often face the tough choice between fixed and variable rates. Fixed rates provide stability but limit flexibility, while variable rates offer potential savings but come with the risk of rising repayments.

A split loan offers a hybrid solution, combining the best of both options. By dividing your home loan into fixed and variable portions, you can enjoy stability and flexibility in one package.

This article explains what split loans are, their pros and cons, and how to decide if they are the right fit for your situation.

What Is a Split Loan?

A split loan, also called a split-rate mortgage, allows you to divide your loan into two parts:

• Fixed Rate Portion: Locked in for a set period (usually one to five years), providing stable and predictable repayments.
• Variable Rate Portion: Fluctuates with market conditions, allowing for flexibility and the possibility of benefiting from rate cuts.

For example, if you have a AUD 500,000 home loan, you might split it 50/50:

• AUD 250,000 fixed, giving you repayment certainty.
• AUD 250,000 variable, giving you flexibility and the potential to benefit from future rate drops.

How Does a Split Loan Work?

Each portion operates independently:

• The fixed-rate portion has a set interest rate and repayment schedule, unaffected by rate changes.
• The variable-rate portion changes based on the lender’s variable rate or movements in the official cash rate.

You make combined repayments that cover both parts.

Advantages of Split Loans

1. Balance of Stability and Flexibility
   You get predictable repayments on the fixed portion and flexibility on the variable side, including the ability to make extra repayments.
2. Potential Interest Savings
   If rates fall, the variable portion helps lower your total interest costs, while the fixed portion protects you if rates rise.
3. Access to Useful Features
   Variable portions often come with offset accounts, redraw facilities, and unlimited extra repayments.
4. Reduced Risk
   A split loan reduces the risk of being locked into an unfavorable rate structure, helping to smooth out the impact of rate movements.
5. Customisation
   You can tailor the split to your needs — common splits include 50/50, 60/40, or 70/30 — depending on your risk tolerance and financial goals.

Disadvantages of Split Loans

1. Complexity
   Managing two portions means tracking different rates, terms, and features, which can be more time-consuming.
2. Limited Benefits if Rates Move Strongly
   If rates drop sharply, the fixed portion won’t benefit. If rates surge, the variable portion will feel the pressure.
3. Additional Fees
   Some lenders charge extra fees for split loan management.
4. Fixed Portion Restrictions
   Fixed loans often have limits on extra repayments and may charge break fees if you refinance or pay off the loan early.
5. Need for Market Awareness
   Making the most of a split loan requires at least a basic understanding of interest rate trends.

When Should You Consider a Split Loan?

• You want stability and flexibility
  If you want the security of predictable repayments but still want to take advantage of rate drops or make extra repayments, a split loan is worth considering.
• You anticipate rate volatility
  In uncertain economic times, splitting your loan helps hedge against the risk of future rate hikes.
• You have a medium or long-term loan
  For loans over several years, split loans provide peace of mind while giving you room to adjust as needed.
• You want customisation
  If you like the idea of tailoring your loan, a split arrangement lets you control the balance between fixed and variable.

Key Factors to Consider

1. Split Ratio
   Decide how much of the loan you want to fix versus keep variable. Common splits are 50/50, 60/40, or 70/30.
2. Market Conditions
   Consider current economic conditions. If rates are rising, you might fix more. If rates are expected to fall, you might keep a larger variable portion.
3. Flexibility Needs
   If you want access to features like an offset account or redraw facility, focus on the variable portion.
4. Loan Term
   Check that the fixed period aligns with your future plans, especially if you plan to sell or refinance.
5. Fees
   Compare lender fees, including account-keeping fees and potential break costs.

Split Loans vs. Other Loan Types

• Split vs. Fully Fixed Loan
  Fixed loans provide full stability but often limit flexibility. Split loans give you both.
• Split vs. Fully Variable Loan
  Variable loans offer maximum flexibility but expose you to rate hikes. Split loans balance flexibility with risk protection.

Real-World Example

Tom and Sarah

• Loan: AUD 600,000
• Split: 60% fixed at 5.5% for three years, 40% variable at 5%

Benefits:

• Fixed portion shields them from rate rises.
• Variable portion lets them make extra repayments or benefit if rates fall.

Outcome:
They enjoy predictable repayments and still have flexibility to manage their loan proactively.

Tips for Managing a Split Loan

• Review regularly
  Check whether your current split still fits your goals and market conditions.
• Plan for fixed term expiry
  Prepare for what will happen when the fixed rate expires — will you refinance or adjust the split?
• Stay informed
  Keep an eye on economic trends to make better decisions about your loan.
• Get professional advice
  Consult a mortgage broker to help design a split that suits your financial needs.
• Account for fees
  Be aware of any extra costs associated with split loans.

Are Split Loans Right for You?

Split loans are ideal for:

• Borrowers wanting both stability and flexibility.
• Homeowners comfortable managing a slightly more complex loan.
• People with medium- to long-term financial plans.
• Buyers looking to reduce risk without committing fully to one rate type.

Final Takeaway

A split loan is a smart tool for balancing the stability of fixed rates with the flexibility of variable rates. While it does involve some complexity and potential fees, it can help you navigate uncertain markets with greater confidence. As with any major financial decision, assess your goals, consider current market conditions, and seek expert advice to ensure the structure fits your needs.