Splitting your home loan

June 15, 2014
Jason Coviello

Splitting your home loan between both fixed a variable rates can be a great strategy that might help you pay off your home loan sooner.

 

Our Perth mortgage customers are always surprised when we show them the potential benefits of using a strategy that involves splitting your home loan to help you repay it sooner.

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You need to know your goals

 

We find that with most of our Perth mortgage customers it’s their goal to repay their home loan as fast a possible.

 

A split loan strategy might just help you to achieve this goal.

 

Split loans explained

 

A split loan allows you to ‘split’ the total loan amount into two loans, where one loan has a variable interest rate while the other has a fixed interest rate.

 

While there are minimum loan amounts which differ from lender to lender, you can generally choose how much of the total loan amount you would like to fix, and how much you would like to leave variable, say 50/50 or 70/30.

 

How splitting might help you repay your loan sooner

 

Everyone’s personal goals and situation are different, however using a split loan strategy to your advantage might just help you repay your home loan sooner.

 

I will reveal how the strategy works in a minute, but first we need to establish the ground rules.

 

In the first years of having your home loan you are repaying mainly the interest owed to the bank, and very little of the actual principal amount.  

 

That’s bad

 

Any extra repayments you make at the same time you make the regular minimum monthly repayment, go directly towards paying down the principal of the loan.  

 

That’s good.

 

If we take these two factors, it would be reasonable to reduce the contracted minimum monthly repayment, so you have more free cash to make extra repayments off the principal, and repay the loan faster.

 

How to decide how your loan splits

 

The second thing our Perth mortgage customers know is that when we talk about fixed rate loan we are usually looking at terms of 2 - 5 years, depending on your goals.

 

In the first few years of having your home loan how much do you think you would pay off a $400,000 loan?

 

Probably not much.

 

You need to determine how much you actually can pay in extra repayments each month.  

 

Then work with your mortgage choice broker to see how much this will amount to in 2,3,4 or 5  years time, as determined by your goals and objectives.

 

Split loans in action

 

Let’s say in this example of a $400,000 home loan, you decide you can repay a total of $80,000 over 3 years, including the minimum contracted payments and extra repayments.

 

If this is the most you can repay in 3 years why would you want to be chipping away at the whole $400,000 when you could lock away $320,000 of this at a fixed rate for 3 years, and be sure of the repayments, then set yourself the goal of totally paying off the remaining $80,000.

 

This is where the split loan strategy can be used with great effect.

 

The idea in this example is to fix $320,000 for a 3 year period with interest only terms, then leave $80,000 on a variable interest rate with principal and interest terms.

 

The result is that you are reducing the amount you pay each month on the larger portion, which means that you should have more free cash to make larger additional repayments on the variable portion, therefore repaying more of the principal, and in the process paying off the $80,000 faster.

 

The risks

 

Of course when considering any fixed rate loan there is always going to be the risk that interest rates will fall further.

 

Depending on the size of your split loans you could be better or worse off if interest rates move in either direction.

 

You would be exposed to the risk that a fall in interest rates would mean you fixed rate loan starts to look expensive.  While on the other hand you variable loan would be better off.

 

How you can find out what’s works for you

 

We highly recommend speaking with Mortgage Choice North Perth to determine your goals and objectives and make sure the split loan strategy is right for you.

 

If you would like to know more about the split loan strategy, and to see if it would be a benefit to you, feel free to call Peter Hale at Mortgage Choice North Perth on 0402 252 150 at any time.  Alternatively you can email peter.hale@mortgagechoice.com.au

 

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Posted in: Home loans

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