Payment Frequency - Mortgage Strategy
There are a lot of factors to consider when deciding how to pay off your mortgage debt, but the extra leg work is well worth the effort. By establishing an effective mortgage strategy, you can save tens of thousands of dollars during the course of your loan and become mortgage free years sooner.
One of the most instrumental and perhaps most overlooked money saving tools is payment frequency. Most lenders will allow you to make your mortgage payments at intervals that suit your needs and preferences. Typically, you have the following options:
Semi - Monthly Payment
Choosing which type of payment to make will be a matter of convenience, but there are many advantages to paying more frequently than monthly. When you increase the payment frequency you reduce the principal faster, pay less interest and pay off your mortgage sooner. To understand the benefits and drawbacks of the different payment frequencies, let's look at them in a bit more detail:
The most common way of paying a mortgage is with monthly payments typically on the 1st of every month. This is easy to remember if you are used to paying rent. Most lending institutions will let you make payments on a different date if that is more convenient for you for example the 15th day of every month. The drawback with monthly payments is simply that they still only occur once a month. This means there is more time in between payments for interest to accrue.
Semi-monthly payments are also pretty straight forward. They're taken twice a month, usually on the 1st and the 15th and each payment is one half of the monthly amount.
Therefore, whether you pay $1,000 in monthly payments or $500 in semi-monthly payments, you're still paying $12,000 per year. As a result, this option saves you very little money because you are paying the same annual amount just a smaller portion more frequently. See the comparison below for an example of the savings.
Again, we're not looking at much of a money savings here. Bi-weekly payments are determined by multiplying the monthly payment by 12 and then dividing by 26. So in our $1,000/month example, the biweekly payment ends up being $461.54 - totalling $12,000 per year.
A very small amount of savings are gained due to half of your payment being made early each month. The main reason for choosing this option would be the convenience of matching your payment to your pay days, with lower payments than the accelerated version.
Bi-Weekly Accelerated Payments
If you're hoping to pay your principle off faster, this is the way to go. Payments are exactly half of a monthly payment amount and collected every two weeks - meaning exactly every 14 days. For example, if the monthly payment is $1,000 then the bi-weekly payment will be $500. This saves you money because you pay an extra $1,000 over a twelve month period.
How? Well, payments are made on the same day every second week or exactly every 14 days. For example if your payments are Fridays, then your payments would fall on say the 4th and 18th. The next month they might fall on the 1st, 15th and 29th. At least twice a year you will have three payments in the month. This results in an extra two payments per year and, in our $1,000/month example, that results in $13,000 per year, rather than $12,000. You will also make an extra small deduction from the mortgage balance because you're making small payments faster than if they were larger, monthly payments.
This is a very easy payment plan to keep up with if you receive a pay cheque every two weeks. If you are paid monthly, or semi-monthly (the 1st and 15th of every month), bi-weekly payments can be very difficult because of the extra payments twice a year. This is because your income does not change, but your mortgage payment will be 1 1/2 times the normal size (e.g.$1,500 rather than $1,000). See the comparison below for an example of the savings.
Regular weekly payments don't make much of a difference in terms of cost savings. The $1,000 monthly payment is multiplied by 12, and then divided by 52. This equals a weekly payment of $230.77 and no surprise at the end of the year you will have ended up paying $12,000. Again, using our example, this is exactly the same amount as monthly.
A very small amount of savings are gained due to three quarters of your payment being made early each month. The main reason for choosing this option would be the convenience of matching your payment to your pay days, with lower payments than the accelerated version.
Weekly Accelerated Payments
Similar to bi-weekly accelerated payments, weekly accelerated payments allow you to pay off your mortgage faster by sneaking in a few extra payments. They are one quarter of your normal monthly payment, but they're made exactly every seven days so you end up making four extra payments per year. In our example, that results in an extra $1,000.
Comparison At A Glance:
The table below shows a comparison of interest saved and the length of time this takes.
For this example, we have used a mortgage of $142,772.35 at 7% for an original amortization of 25 years.