Pros and cons of splitting your home loan
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Pros and cons of splitting your home loan

Pros and cons of splitting your home loan

by Bianca Dabu | April 14, 2018

There are two main home loan options for investors—fixed rate home loans or variable rate home loans—but if you are looking to gain more flexibility, you may consider ‘getting the best of both worlds’ by splitting your home loan.

Fixed rate home loans allows for a set interest rate for a specific period of time, which usually ranges from one to five years. Additional repayments are often not allowed or limited to a low amount.

When the term ends, the loan is often automatically switched to a standard variable rate home loan offered by the lender.

Since the interest rate is fixed, you will not be affected by interest rate hikes for as long as your loan term lasts. Moreover, since the repayments you have to make are set for a specified term, budgeting becomes easier.

However, when interest rates drop, you won’t be able to benefit from it.

Under a fixed rate home loan, you may also be incapable of redrawing or accessing any extra money you have deposited into your loan, and should you decide to change or pay off your loan prior to the end of the fixed term, you may be required to pay break fees.

On the other hand, variable rate home loans follows market movements to determine the interest rate, meaning it can rise and fall anytime. Therefore, the loan repayments you have to make may vary throughout the term of your loan.

Unlike fixed rate home loans, variable rate home loans often allow you to make extra repayments with no additional cost.

Aside from that, you may also enjoy more attractive features, including unlimited redraws on extra repayments and access to an offset account. It may also be easier and cheaper to switch home loans in case you find a better deal.

However, since there is no certainty on the amount of loan repayments you have to make, it can be harder to stick to a certain budget, especially when interest rates rise.

What are split home loans?

Apart from the two options stated above, you can also opt to split your loan and make it part fixed and part variable.

Split home loans are often utilised by investors who wants both security and flexibility—as in be able to manage the risk of rising interest rates while still maintaining the ability to make extra repayments.

The allocation of your desired interest rate model is usually up to the investor, so you can split your loans 50/50, 20/80, 60/40 or however you want.

Advantages

Split home loans are often most beneficial when the market is especially unpredictable, particularly during economic uncertainty.

Through this home loan arrangement, you reduce the impact of interest rate fluctuations on your home loan since it only affects a part of it, and you also retain the ability to take advantage of rate reductions through the portion of your loan with a variable rate.

In other words, you are given a sense of security regardless of how the market moves.

Moreover, you can also maintain the flexibility offered in the variable part of your loan—as in make extra repayments or take advantage of the redraw facility.

Disadvantages

Getting the ‘best of both worlds’ also means having to deal with both of their bad sides.

While you are partly protected from rate hikes, you are also refrained from benefiting fully from rate reductions, which could mean extra costs on the fixed part of your loan should interest rates drop significantly.

You may also incur double the fees for setting up and managing your loan, all the way to discharging it.

Making a decision

Naturally, all types of home loan have accompanying risks.

In order to avoid unexpected costs and pitfalls, take time to discuss your investment plan with a mortgage broker and the rest of your financial team.

Consider the features you want to enjoy, from flexibility to fees, and make a decision based on your personal and financial circumstances—as in your needs, capabilities and limitations.

Some of the fees you have to take into account are establishment fees, Lender’s Mortgage Insurance (LMI), ongoing fees, breaking fees, early exit fees, discharge fees and refinancing fees.

Moreover, review the credit contract well to know exactly what you’re signing up for.

Different lenders have different rules that they follow, so make sure that you’re reading the contract down to the fineprint.

Some of the information to look out for are the name of the lender, the features and other details of the loan, the calculation and charging of interest, fees and charges, as well as commissions and insurance premiums (if applicable).

You also need to know the terms of missing repayments, the schedule and process of receiving account statements and the communication of terms and conditions amendments.

Aside from having a dialogue with property professionals, you can also educate yourself by utilising comparison website to compare loans and see what’s the best fit for your wealth-creation journey.

For more information, check out Smart Property Investment’s Split Loan Calculator.

This information is sourced from Momentum Wealth and the Australian Securities & Investments Commission.

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