Is it time to split your loan?

There is so much debate and speculation about interest rates lately it's hard to know what to do with your home loan. Do you stay with a variable rate and bank on the RBA cutting the cash rate again? Or do you think rates have gone as low as they are going? Does this mean you should choose a fixed-rate loan?

Interest rates are already at historic lows, with standard variable rates starting at 4.23 per cent and new fixed-rate loan products are being launched into the market with growing frequency. It means you don’t have a bad option, really, but how do you know what is the best choice?

In recent months you may have found yourself among the thousands of Australian home-owners poring over news reports about the latest economic indicators and opinion pieces by noted analysts who predict that the RBA will cut, or hold, the cash rate. When interest rates get as low as they are, the temptation to fix your home loan interest rate is almost too great to bear  – but the possibility of yet another rate cut is tantalising. What if you fix too soon and rates drop again? There is some talk of the RBA cutting the cash rate at least one more time this year. But what if they don’t?

The truth is, there aren’t many people who have experienced interest rates as low as they are now, so first-hand knowledge of these market conditions is hard to find. Reading the tea leaves on what your mortgage interest rate is likely to do is more art than science: even the most skilled finance experts don’t usually agree. Even if they are correct in their forecasts of the RBA’s moves on the cash rate, there is no way to know whether or not your lender will pass on any cuts. They aren’t obliged to.

Fixed and variable loans have their strengths and weaknesses. Usually, a variable loan will let you take advantage of an interest rate cut; a fixed rate will not. But a fixed rate will protect you from an interest rate rise, which a variable loan will not. Often, a fixed rate loan does not let you make extra repayments, but a variable loan does. A fixed loan gives you certainty over your interest rate, and a variable loan does not.

So what is the best strategy for minimising the interest you pay on your home loan when interest rates are low, but unstable? You could always try hedging your bets.

If you have chosen a flexible home loan, you should have the option to split your loan into fixed and variable. A split loan means you nominate the percentage of the loan amount that will attract a variable interest rate, and what will be on a fixed rate. You should also be able to choose how long the fixed term will be.

A split loan will let you make extra repayments on a variable interest rate to get the principal down while interest rates are low, but will not leave you totally exposed to an interest rate rise because a portion of your loan is on a fixed interest rate.

A split loan lets you have your cake and eat it, too.