Split Loans

As the world economy becomes more difficult to predict it gets even harder for borrowers to work out whether it's better to have a fixed rate or a variable rate home loan. Every borrower wants to have as much certainty as they can get but over the last 2 years we have seen interest rates dropped to record low levels and then bounce back up to normal levels within a very short time. The old practice of banks following the reserve bank's changes in interest rates seem to have disappeared as banks embarked on a practice of charging whatever they can get away with.

While the banks argue that they have to change rates to protect their shareholders returns, there is little comfort for borrowers who are the ones actually paying the loan off every month. Fixed rates have often been a haven for borrowers who want stability, but as we know, fixed rates have a sting in the tail especially when variable rates continue to drop.

A fixed rate loan is determined individually by each lender. There is little influence from the reserve bank or by the government in this regard. Fixed rates are largely determined by each bank's costs of borrowing on the money market and interbank lending practices. The global financial crisis placed a squeeze on this area of banking operation and funds largely dried up, driving fixed rates even higher.

In the first 6 months of 2010 stability began to return to the market and fixed rates began to become more attractive. By mid-2010 there was little difference between fixed rates on variable rates with most lenders who offered terms of between 3 and 5 years.

But it is still very difficult to work out whether a fixed rate will be a good gamble not, and that is where split loans come into play.

What is a split loan?

A split loan is simply a facility whereby a borrower can opt to have their loans split into various portions with each portion attracting either a variable rate or fixed rate of interest.

For example, a borrower with a loan of $300,000 can have the loan split into 2 parts one part variable and the other part fixed. There is no restraint on the amount of loan which can be allocated to each split for example the same borrower could opt for $100,000 to remain variable, and the remaining $200,000 to be placed on a 3 year fixed rate.

Similarly, the borrower could opt for a variable portion of $50,000, a fixed rate for 3 years on $100,000, and a fixed rate of 5 years on the remaining $150,000.

In other words the borrower can choose the amount of each split and the type of facility each split will be.

Here is a summary of how a split loan works.

The borrower can choose to split the loan into as many parts as they wish.

The borrower chooses the type of loan that will apply to each of the splits chosen.

There will be a fee payable for each split.

Each split loan will be treated as a separate facility. Note that each bank attaches conditions to various loan types and the same will apply to the splits too.

Having the choice of splitting the loan may look good on paper are there any real benefits?

The short answer is yes because it gives borrowers an infinitely flexible method of spreading the risk of fixed rates. The best way to decide on how the splits should be organised is to have a financial analysis done by a mortgage broker or finance professional. The first step is to do a budget to work out how much you can comfortably afford to repay on your home loan. With this knowledge you can then perform a number of analyses to see which structure is go to suit your cash flow best before locking yourself into anything.

Any loan which involves a fixed rate should only be undertaken with care and specialist advice because there are many limitations on fixed rates, especially when it comes to making extra payments to pay off your home loan sooner, not to mention the potential of prohibitive exit fees if you want to sell your house, or refinance or change the fixed rate to a variable rate.

If your family income is likely to change in the near future it's a good opportunity to examine how a split loan could suit your changing circumstances, and this type of facility can give you great peace of mind as well as allow you to manage your finances effectively, especially where you have chosen to pay more per month so you can pay off your home loan as soon as possible.

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