Split loans: combining fixed and variable rates

A split loan, which Moneysmart also calls a partially-fixed rate loan, divides a single home loan into two accounts: one charged a fixed interest rate for a set period and one charged a variable rate. The borrower decides the proportions. The fixed portion gives certainty over part of the repayments, while the variable portion retains flexibility, usually including unlimited extra repayments and access to an offset account or redraw.

A split does not produce a lower cost than the alternatives in every rate environment. Its purpose is to narrow the range of outcomes: repayments rise by less than a fully variable loan if rates increase, and fall by less if rates decrease. It is a way of managing uncertainty rather than a prediction about where rates are heading.

How a split home loan works

When a loan is split, the lender creates two loan accounts secured by the same property, generally under one application and one set of loan documents. Each account has its own balance, interest rate, minimum repayment and, in many cases, its own repayment date. Some lenders allow more than two splits, for instance two fixed portions with different terms alongside a variable portion.

The two accounts then behave as their type normally would:

• Fixed portion. The rate and the minimum repayment are locked for the fixed term, commonly between one and five years. At the end of the term the account reverts to a variable rate unless the borrower arranges another fixed rate.
• Variable portion. The rate moves when the lender changes its variable rates, which often, though not always, follows changes in the Reserve Bank cash rate. The repayment is recalculated when the rate changes.

Split loans are common in Australia. A Reserve Bank Bulletin article published in March 2023 reported that over half of the major banks' owner-occupier customers with fixed rate loans had a split loan with both fixed and variable components. The same article noted that these borrowers tended to show savings behaviour similar to variable rate borrowers. General background on the two rate types is available in the interest rates section.

Choosing the fixed and variable proportions

Moneysmart gives 50/50 and 20/80 as examples of how a loan may be divided, and there is no standard proportion. Lenders may set a minimum amount for each account. The following considerations tend to drive the decision.

How much repayment certainty the budget needs

A household with little room in its budget may value a larger fixed portion, because a rate rise then affects a smaller share of the debt. Moneysmart suggests borrowers test what their costs would be if interest rates rose by 2 per cent. Running that test on the variable portion alone shows how much protection a given split provides. The mortgage repayment calculator can be used for each portion separately.

How much the borrower expects to repay early

The variable portion is where extra repayments and offset savings usually go. A practical approach is to estimate the savings and extra repayments expected over the fixed term, and make the variable portion at least that large. If the variable portion is repaid in full part way through the fixed term, further surplus cash has nowhere to go except the restricted fixed account or an ordinary savings account.

Whether circumstances may change

A borrower who may sell, refinance or restructure within a few years faces possible break costs on whatever is fixed. A smaller fixed portion, or a shorter fixed term, reduces that exposure.

The relative pricing of fixed and variable rates

Fixed rates reflect market expectations of future rates, so a fixed rate below the variable rate often signals that markets expect rates to fall, and the reverse. A fixed rate that looks cheap on the day it is taken is therefore not a reliable indicator of savings over the full term.

Offset accounts and extra repayments on each portion

Feature rules differ sharply between the two accounts, and they vary by lender, so the loan terms need to be checked.

Feature	Fixed portion	Variable portion
Extra repayments	Often capped for the fixed term or not permitted	Generally unlimited
Offset account	Uncommon, and sometimes partial only	Commonly available, often a full offset
Redraw	Often unavailable during the fixed term	Commonly available, subject to loan terms
Repayment amount	Unchanged for the fixed term	Changes when the variable rate changes
Cost of early exit	Break costs may apply	Usually a discharge fee only

The Reserve Bank's March 2023 article reported that fully fixed loans typically restrict prepayments, that the median allowance among major lenders was $10,000 per year of the fixed term, and that only about 15 per cent of fully fixed loans had an offset facility. Those figures describe the market at that time and individual products differ.

One point is easy to miss. An offset account linked to the variable account only reduces interest on the variable balance. If the offset balance exceeds the variable loan balance, the excess generally earns no benefit. Borrowers who expect to hold $80,000 in savings, for example, may not wish to leave a variable portion of only $50,000. The offset account calculator and extra repayment calculator can help size the variable portion.

Break costs on the fixed portion

Moneysmart lists the possibility of a break fee as a disadvantage of fixed rates, and includes it among the costs to check before switching loans. Break costs can arise when, during the fixed term, a borrower repays the fixed account in full, makes extra repayments above the permitted cap, switches that portion to a variable rate or refinances to another lender.

Lenders generally describe the charge as recovery of their economic loss. In broad terms, that loss depends on three things: the amount being repaid early, the time remaining in the fixed term, and how far the lender's relevant funding rates have fallen since the rate was fixed. If rates have risen or stayed level since fixing, the cost may be small or nil. If rates have fallen materially, the cost can run to thousands of dollars.

As a rough illustration only, a fall of 1.00 percentage point in the relevant rate, applied to $300,000 with two years of the fixed term remaining, suggests an order of magnitude of $300,000 × 1.00% × 2, or about $6,000. Lenders use their own formulas, based on wholesale rather than retail rates and with discounting, so an actual quote may differ considerably. A lender can provide a break cost estimate on request, and it is prudent to obtain one before acting.

In a split loan, only the fixed account is exposed. The variable account can be reduced, repaid or, in some cases, refinanced without break costs, although moving one portion to another lender is usually impractical because both accounts share the same security.

Worked example: repayments under a rate rise and a rate fall

The following hypothetical figures are illustrative only. They assume a $600,000 principal and interest loan over 30 years, with both the fixed and variable rates at 6.00 per cent on the day of settlement. These rates are assumptions, not current market rates. For simplicity, the variable rate is assumed to move by 1.00 percentage point shortly after settlement, and repayments are calculated on the original balances.

Loan structure	Monthly repayment at start	Variable rate rises to 7.00%	Variable rate falls to 5.00%
Fully variable	$3,597	$3,992	$3,221
Split: 30% fixed, 70% variable	$3,597	$3,873	$3,334
Split: 50% fixed, 50% variable	$3,597	$3,795	$3,409
Split: 70% fixed, 30% variable	$3,597	$3,716	$3,484
Fully fixed	$3,597	$3,597	$3,597

Taking the 50/50 split, each $300,000 account starts with a repayment of $1,799 a month. After the rate rise, the variable account's repayment becomes $1,996 while the fixed account stays at $1,799, for a total of $3,795. That is an increase of about $197 a month, compared with about $395 a month for a fully variable loan. After the rate fall, the variable account's repayment drops to $1,610 and the total to $3,409, a reduction of about $188 a month, compared with about $376 for a fully variable loan.

In each scenario, the split delivers roughly half of the movement. The borrower gives up half of the benefit of a fall in exchange for protection against half of a rise. The fixed versus variable calculator can model other rates and proportions.

What happens when the fixed term ends

At expiry, the fixed account usually reverts to one of the lender's variable rates, which may not be its most competitive one. The Reserve Bank's 2023 analysis of loans fixed at very low rates noted that many of those borrowers faced scheduled payment increases of 30 per cent or more when they rolled onto variable rates, which shows how large the adjustment can be when the gap between the old fixed rate and the prevailing variable rate is wide. A split reduces the size of this step because only part of the debt reprices at expiry.

In the months before expiry, borrowers may wish to:

1. ask the lender what the revert rate will be and whether a lower rate is available;
2. compare the offer with other lenders using the home loan comparison page;
3. decide whether to fix again, in what proportion, or move wholly to variable;
4. consider the costs and benefits of refinancing, which carries no break cost once the fixed term has ended.

Common mistakes with split loans

• Making the variable portion too small. This limits the usefulness of the offset account and the scope for extra repayments.
• Fixing for longer than plans are certain. A sale or restructure during the fixed term can trigger break costs.
• Exceeding the extra repayment cap. Payments above the cap on the fixed account may attract a charge.
• Treating the split as a rate forecast. The structure manages risk. It is not a means of outperforming the market.
• Overlooking fees. Some lenders charge a fee for each split account or a rate lock fee to secure the fixed rate before settlement.

Who a split loan tends to suit

A split loan tends to suit borrowers who want a degree of repayment certainty but also hold savings, expect to make extra repayments, or are unsure about the direction of rates. It may be less suitable for borrowers who expect to sell or refinance soon, for whom break costs are a meaningful risk, or for those whose budgets could not absorb any increase, who may prefer to fix a larger share. The overview of home loan types explains the alternatives. A licensed mortgage broker or adviser can assess which structure fits an individual's circumstances.