Comparing Split Loans vs. Fixed-Rate Loans for Mortgagors: Which Structure Offers Better Protection Against Fluctuating Interest Rates?
When it comes to mortgages, Australians overwhelmingly choose variable interest rate loans over ones with fixed interest rates.
There is a rarely used solution, a mix of fixed and variable loan, a hybrid solution that allows the mortgagor to potentially reduce their loan balance faster with flexibility as well as repayment certainty.
Understanding Split Loans and Fixed-Rate Loans
Split Loan: A split loan divides your mortgage into two parts: one portion is fixed, and the other is variable. This provides a combination of certainty and flexibility.
Fixed-Rate Loan: With a fixed-rate loan, your interest rate remains locked for a set period (usually 1-5 years). Your repayments will not change during this time, offering protection from interest rate rises but limiting flexibility.
Benefits and Drawbacks
Split Loan Benefits:
• Balance of certainty and flexibility: You can hedge part of your loan against rate hikes while keeping part open to benefit from rate drops.
• Access to features: The variable portion often allows redraw, offset accounts, and extra repayments.
• Tailored risk management: You can choose the split percentage based on your risk tolerance.
Split Loan Drawbacks:
• Complexity: Managing two loan portions can be confusing.
• Potential fees: Lenders may charge higher fees for managing a split structure.
Fixed-Rate Loan Benefits:
• Certainty of repayments: Great for budgeting, especially in rising rate environments.
• Protection against hikes: If the Reserve Bank of Australia (RBA) increases rates, your repayments stay the same.
Fixed-Rate Loan Drawbacks:
• Break costs: Significant penalties may apply if you refinance or pay off early.
• Limited features: Redraw and offset features are often restricted.
• No benefit if rates fall: You miss out on savings if interest rates drop during your fixed period.
Realistic Calculations: Payment Differences
Let's assume a $750,000 loan over 30 years. We will compare three scenarios:
| Scenario | Loan Type | Interest Rate(s) | Monthly Repayment |
|---|---|---|---|
| 1 | Fixed | 5.45% fixed 3 years | $4,246 |
| 2 | Split (50/50) | 5.45% on $375k, 6.04% on $375k | $4,417 |
| 3 | Variable | 6.04% | $4,515 |
Key Takeaways:
• Fixed loan: Provides immediate payment certainty.
• Split loan: Payments are slightly higher but offer flexibility.
• Full variable: Higher initial repayments but potential to benefit if rates fall.
Rate Movement Scenarios
If Rates Rise by 1%:
• Fixed Loan: No change in repayments during fixed period.
• Split Loan: Variable portion rises. Approximate new repayment: $4,602.
• Variable Loan: Approximate new repayment: $4,696.
If Rates Fall by 1%:
• Fixed Loan: No change until fixed term ends.
• Split Loan: Variable portion drops. Approximate new repayment: $4,238.
• Variable Loan: Approximate new repayment: $4,025.
Borrowing Solution Based on Buyer Profiles
First Home Buyers:
Solution: Consider a split loan.
Reason: First-time buyers benefit from certainty for budgeting purposes (fixed portion) while retaining flexibility (variable portion) to make extra repayments or benefit from potential rate drops.
Investors:
Solution: Fixed loan, particularly if rates are forecasted to rise.
Reason: Helps lock in predictable costs, improving cash flow forecasting and yield stability.
Upsizers and Growing Families:
Solution: Split loan with a higher fixed proportion (e.g., 70% fixed / 30% variable).
Reason: Greater certainty during a financially sensitive life stage but still allows access to an offset account.
Refinancers:
Solution: Caution with full fixed loans unless planning to stay long term.
Reason: High break costs could negate refinancing benefits if you plan to move or restructure soon.
Recent Client Experiences: Insights from the Field
Case Study 1: A Sydney couple chose a 70/30 split on their $800,000 loan. When rates rose by 1% in 2023, they only felt the rise on the variable portion, saving them around $400 per month compared to friends with fully variable loans.
Case Study 2: A Melbourne investor fixed 100% of his $500,000 investment loan for 3 years in 2022 at 2.89%. With rates now over 6%, he's saving approximately $9,300 annually compared to new borrowers. However, he is now facing high break costs to refinance as he seeks to unlock equity.
Case Study 3: A Brisbane first-home buyer took a 50/50 split in 2021. The flexibility of making extra repayments to the variable side helped them reduce their loan balance by $20,000 faster than scheduled, significantly reducing their interest burden.
Which Structure Offers Better Protection?
• If you want maximum certainty: Fixed-rate loans are ideal.
• If you want flexibility and moderate protection: Split loans offer the best balance.
• If you are highly rate-sensitive or need access to features like offset accounts: A well-structured split loan will likely serve you better.
Choosing between a split loan and a fixed-rate loan is not a one-size-fits-all decision. It requires careful consideration of your financial goals, lifestyle needs, and risk tolerance.
Given the recent RBA rate movements and economic forecasts pointing to continued fluctuations, many Australian borrowers are increasingly opting for split loans to blend security with flexibility.
The right loan structure can save you thousands and provide greater peace of mind in a volatile market.