Is it preferable to pay your mortgage weekly, biweekly, or once per month?
by Glen Jacobs
We often hear that it is better to make mortgage payments every week or every two weeks, but is it really true?
What is the impact of this strategy?
To analyze this question, we must first define two possibilities:
- accelerated weekly payments
- minimum weekly payments
|
|
| |
Description
The most common method is accelerated weekly payments. This is actually the monthly payment divided by 4. In reality there are not four weeks in a month, but a little more. This method is called accelerated payment because it introduces 4 additional weekly payments over the course of the year, and thus increases the total payment on the principal.
The other method is minimal weekly payments. This is the minimum amount that you should pay each week to settle your mortgage by the end of its term.
These two methods clearly do not provide the same savings. Minimal weekly payments only increase the frequency of payment from 12 times per year to 52 times per year; accelerated weekly payments not only augment the frequency, but also add 4 supplementary installments.
Let’s look at the results of my investigation of these two cases.
Minimal weekly payments
Summary:
- Minimal weekly payments save $1294.12 on a $200,000 loan amortized over 25 years at an interest rate of 5.4%, compared to monthly payments.
- The higher the interest rate, the more effective weekly payments are. When the rate doubles, the savings are 7.08 times larger.
- There is 43% more savings by weekly payments than by biweekly payments, no matter what the interest rate is.
Why?
The explanation is simple, but difficult to describe. Given that there is less time between payments, part of each month’s principal is repaid a little earlier than it normally would be and this reduces the overall interest paid on the mortgage. The savings are minimal on each payment, but add up with time.
Conclusion: More frequent payments increase savings even if they don’t increase the amount to be paid. If possible, make weekly payments; if not, make them biweekly.
Accelerated weekly payments
Summary:
- The method of accelerated weekly payments increases the amount reimbursed by $23.25 per week, on a $200,000 loan amortized over 25 years at an interest rate of 5.4%.
- The house ($200,000) will be paid for in 1107 weeks, or 21.3 years.
- The savings will be $23,173.781 (the calculations are given below this article)
- It would be better not to make accelerated payments if you have a safe or guaranteed investment that pays 7.52% annual interest before taxes.
Explanation: In addition to augmenting the frequency of payment, the supplementary payments (4 per year) on the mortgage reduce the principal even faster. The lender does not charge you any further interest on principal that has been paid, which means that you save all the future interest on any principal reimbursed early.
Conclusion: Regardless of your financial situation, you should make weekly or biweekly payments on your mortgage if possible. But if you can increase your weekly payments, do it!
Making accelerated payments is the preferable choice, unless you have a guaranteed investment with an annual return of 7.52%.2 This is very unlikely.
Choosing the right payment method for your mortgage is important, but much less important than choosing the right mortgage strategy.
|
1 - If you purchase a home and need a financing of 200,000$ ( with an interest rate of 5.4%) and you pay your mortgage once per month (1209.16$ per month), you would have paid 362 749.83$ over 25 years (200,000$ plus 162 749.83$ of interests); however with accelerated weekly payments (302.29$ per week), you would have paid 334 576.05$ (200 000$ plus 134 576.05$ of interests) in 1107 weeks or 21.3 years. That’s a savings of 28 173.78$ (362 749.83 – 334.576.05$) to pay off the same original mortgage.
2 - The guarantied interest rate with an investment needed to equal the savings of the accelerated weekly method of payments is 7.5246% if you consider a 40% marginal tax rate and that the investment will grow sheltered from taxes until it is used 21.3 years latter.
Let’s compare 2 scenarios:
- Person A take a mortgage of 200,000$ at 5.4% and pays 302.29$ per week for 1107 weeks or 21.3 years. When his mortgage is completely paid, Person A has paid 134,576.31$ in interest.
Person B takes a mortgage of 200,000$ at 5.4% and pays 278.56 per week for 1300 weeks or 25 years. On the same day he starts an investment savings program of 23.73$ per week that pays 7.5246%. His total weekly payment are 278.56$ plus 23.73 or 302.29$ per week (exactly the amount paid by Person A).
After 1107 weeks, Person B analyses the situation to see if he has enough money in his investment plan to pay off his mortgage. The lender tells him that he still owes 48 755.04$ (payments 308 368.13$ of which 157 123.17$ is interest); his investment advisers lets him know that the 23.73$ per week had grown to a before tax amount of 63 745.66$ (invested capital: 26 269.11$ and 37 476.55$ in interests.) after 1107 weeks (ROI 7.5246%). Since his expected marginal income tax rate is 40%, he will have to pay 14 990.62% in taxes, which leaves him 48 755.04$ (63 745.66$ - 14 990.62) just enough to pay off his mortgage.
|
