in your best interests
We are asked about splitting loans a lot just now, and in general it is something we tend to recommend for our clients. However, it may not be right for you! Read on to find out the pros and cons.
A fixed rate loan has an interest rate that will not vary for a set period of time. For example, a 3 year fixed rate loan will not change over that period. No going up, no going down - no matter what is happening in the market.
This is particularly good when you are in a rising interest rate environment as you aren't affected by the increase during that 3 year period.
However, if you set all of your loan on a 3 year fixed rate (for example) when that fixed rate expires all of your debt will be exposed to the interest rates at the time. And therein lies the risk.
We are pretty much at the interest rate trough at present, which suggests interest rates are only going to go one way over the coming months/years - and that is up.
Repaying a nice 3 year fixed rate now is probably just fine, but repaying a higher interest rate (and therefore higher loan repayments) in 3 years time could be quite a shock to your system/wallet/bank account!
So, what's an alternative?...
For a lot of clients we find that hedging your bets is a great way to plan ahead. By hedging bets we mean not having all your debt in one fixed rate, but splitting your total loan across 3-4 different, smaller loans on different fixed rate terms with a 'dash' of variable/floating rate in there for good measure.
So why do this?
By staggering your fixed rate loans you can have funds maturing every 12 months for the next 3 years or so. This allows us to review your position annually, and make adjustments accordingly. It also means you aren't too exposed to any one rate/term and are protected should interest rates rise, but also remain flexible enough to take advantage of changes should rates fall.
Why Include a Variable Rate?
Variable rate loans add flexibility to your loan structure. Fixed rate loans can't be repaid too quickly or you will be stung with early repayment fees (booo!). However, by adding a variable portion into your structure you are able to repay this much faster should you want to, or are in a position to do so. For clients who receive bonuses, have extra cash some months etc this can be ideal and can get you ahead much quicker.
Sounds Good - So Why Wouldn't I Do This?
This structure works well for a lot of clients, but unfortunately this isn't a 'one-size-fits-all solution'.
Having loans maturing at different times does make refinancing more difficult as break fees become a lot harder to avoid. If your circumstances are likely to change significantly this method may not be the best way forward.
It is also slightly more complicated, so splitting loans should really be done with the help of a professional adviser. We can certainly assist here, so contact us anytime if this is something you'd like to discuss/consider.
As you can probably imagine there are a hundred and one ways to structure your loans, which is why it pays to engage a professional to help you. The wrong structure can result in some serious regret further down the line (emotionally and financially), but if you get it right it can save you loads over the lifetime of the loans.