Why some mortgage advisers say splitting is good when interest rates are low

There is no one answer.

Over the past 12 months interest rates have fallen 2.5.% and mortgage borrowers are wondering whether they will miss out on even better deals if they fix when term rolls over.

About $135 billion of fixed mortgage debt is due to be rolled over in the next six months. Until recently a sizeable chunk of borrowers opted for floating or shorter-term fixed rates in anticipation of interest rates dropping further.

Recently there has been a swing to one-year fixed rates, with borrowers hedging their bets on further interest rate drops.

The question now is how much further will rates drop, especially the two-year rate of about 4.75% offered by the major banks. Most bank economists say any further substantial cuts have already occurred.

Timing the market to take advantage of falling interest rates is top of borrowers’ minds, but as mortgage adviser Campbell Hastie points out their ability to predict interest rates movements is as good as gazing into a crystal ball.

Attractive borrowing costs
The Reserve Bank’s own 20-year data show a compelling story about where the rates sit now and why most people are approaching this decision the wrong way, he says.

“What the data show is eye-opening – interest rates being under 5% doesn’t happen that often. When it does occur, it’s usually taken some kind of major catastrophe to get them there and they don’t stay there for long.”

Hastie says the fact they are under 5% now is good. “In the context of the past two decades these are attractive borrowing costs, not something to being waiting around hoping for better.”

He says he understands why borrowers have become accustomed to rates falling as that has been the story for the past year, but if they look at the bigger picture, the question is whether they are going to take advantage of the favourable rates or hope for something even better that might not come.

When he and other mortgage advisers are asked by clients whether to fix long or wait for rates to keep falling, their response is often “why are you making an either or decision?”

Citing a recent case, Hastie says the client was wrestling with this dilemma. He had a $750,000 mortgage locked in at an “excellent” 3.4% rate with an approaching expiry, a renewal rate of about 5% and a substantial increase in loan repayments.

As a fan along with many other mortgages advisers of split mortgages, Hastie says had the client structured his mortgage several years earlier, he could have staggered this financial impact – absorbing portions of the increase across different periods rather than facing the full brunt simultaneously.

“Instead, he had fallen into a pattern than affects countless borrowers: approaching each renewal period reactively, making hasty decisions based on whatever appears acceptable at the time without any strategic forethought.”

Frustrating
He says what frustrates him is when he hears mortgage advisers making blanket recommendations at seminars. He recently heard an adviser telling everyone at a presentation to fix for 12 months.

“A blanket recommendation like that could cost a borrower thousands of dollars. Context is everything. Advice like that has to be filtered through people’s specific situations. For example, if a borrower regularly makes lump sum payments having their mortgage on floating terms might make more sense.”

What Hastie says he has noticed over the years he has been an adviser is few people want extreme solutions – most are happy with a middle-ground approach because it gives them wriggle room either way. “Most sensible people spread their bets to improve their chances.”

He says the same principle applies to mortgage splitting.

Pros and cons
Benchmark Mortgages director Manshil Krishna says while splitting can present a valuable solution for homeowners, it is important to understand both its potential drawbacks and benefits.

Splitting a mortgage enables a borrower to take advantage of different interest rate terms and to also tailor their mortgage to their financial goals and risk appetite.

While there are benefits to splitting a mortgage, there are also some drawbacks. One notable disadvantage is that it can make refinancing more challenging, he says.

If a borrower decides to switch banks or lenders, they may incur additional costs associated with each tranche of the mortgage.

However, negotiating a better deal is often easier when the bank perceives a borrower is at a higher risk of leaving. Krishna says this is particularly true when rates fall, as the borrower may incur break fees when restructuring their loan.