When I bought my first house way back in the beginning of 2000, I set up the mortgage payments to be withdrawn from my account every week. I had heard and read that making payments more frequently would reduce the time necessary to pay off the mortgage significantly. Instead of keeping the money in my account and paying a monthly payment at the end of the month, you would save on interest by paying the weekly amounts ahead of time.
So what happened? Well, I hated the weekly payment because at the time I was being paid twice a month so every few months there would be three mortgage payments in one pay period which would mess up my budget. I decided to switch the payments to semi-monthly to match my pay cheques.
Does this mean I’m paying thousand$ more in interest costs? Not a chance! I had a conversation with a good friend of mine around the time I switched from weekly to semi-monthly payments and he explained to to me that the reason that “weekly” payments (as promoted by the banks) pay the mortgage down quicker is because you are paying more to the principal, not because you are making more frequent payments.
For example if your monthly mortgage payment is $1200 then if you want to do weekly payments, the bank divides the monthly payment by four which means your weekly payment is $300. The problem is that there are more than four weeks per month so by paying one quarter of the monthly payment each week, you are in effect paying more money into your mortgage.
Over the course of one year, $1200 per month total $14,400. $300 per week totals $15,600 over the year which is $1300 per month which is a $100 more than our original monthly payment. This is why the “weekly” payment method pays down the mortgage faster.
What does all this mean?
Don’t worry about the frequency of your mortgage payment, just set it up so it fits your budget and pay schedule.
Increasing your total payments along with occasional extra payments will result in a mortgage that is paid down quicker. Whether you pay daily, weekly, bi-weekly, fortnightly, semi-monthly, thrice monthly or once a month (as I do) you should consider the total amount you pay each month and try to keep that as high as possible.
{ 32 comments… read them below or add one }
One of the more common modes of payment is accelerated bi-weekly, which we use. The same principle applies to this as you have described. You get extra payments in there. This is suppose to reduce your ammortization from 25 years to I think ~21 years 6 months.
I like this system as if you or your spouse happens to get paid on that day, then your really don’t even notice the mortgage payment. I think my wife’s maternity leave EI cheque will go in on that day as her regular pay was doing previously, this is the perfect set up in my opinion.
Actually, you should save with weekly payments even when you pay the same total over the course of a year (so $276.92/week to get $14400 for a year), because the higher frequency means the interest doesn’t have as long to compound. Of course, the difference isn’t anywhere near as much when you’re not sneaking that extra payment in. For a $100k mortgage at 7% annual rate with $14400 in payments yearly, I calculate a difference of $32 for paying monthly vs weekly. When the difference is fairly small like that, it might very well be worth your sanity to only pay at a frequency that matches your pay.
MG – I agree that the payments should match your paycheques in some way.
Potato – you are absolutely right. I didn’t get into it in the post but there is a very small saving from making more frequent payments. As you say, it’s such a small difference that’s it’s not worth worrying about.
Mike
Are you sure the bank calculates the interest on your mortgage on a daily basis, like on a savings account? My understanding is that they do this monthly, but I have to admit I was too lazy to search in my mortgage documents.
If you REALLY want to save money, take MrsMicahs snowflake pattern and combine it with early mortgage payments.
Make a small payment EVERY DAY!!
(just kidding, but it’s possible. 🙂 )
Really, if you’re doing this extra-payments through a third-party company rather than yourself, beware that they might not apply it like you hope. Some companies save up the extra payments FOR AN ENTIRE YEAR, then make a full one-time payment to the mortgage company.
They get the interest from depositing your EXTRA payments in the bank, until they make that one large extra payment each year.
Vasile,
Mortgage interest in Canada is calculated twice yearly.
I’ve thought about this too – the biweekly system is talked about a lot, but I know I can manage extra payments on my own. At the start of the mortgage you’re paying so much interest that a little extra going directly to the principal could go a long way – not that it hurts to do it later on either.
Telly – if interest is calculated twice yearly then does that mean you could make payments twice a year and pay the same amount of interest as someone paying monthly?
In high school my math teacher spent a whole class going through the calculations of weekly vs. monthly payments for a mortgage, and the weekly payments came out to be much less because of paying less interest. However, the assumption was that the interest was compounded weekly or monthly, which is actually not the case. Interest is compounded semi-annually (in Canada). Ideally you should make your mortgage payments semi-annually and build your payments up in a high interest savings account.
Mike,
I don’t know if any Canadian banks allow only two payments a year but I suppose if it were possible and you made your payments just prior to the interest calculation date then yes, it would be the same!
what actually happens is the rate that is quoted is a semi-annual interest rate. If you are paying to the bank on a semi-monthly basis then they will convert the semi-annual interest rate into a semi-monthly rate and use this rate. If this were not the case then going from a monthly payment of 1000/month to two semi-monthly payments of 500/month would have the exact same amortization period.
That makes sense Commander T. Thanks for clearing that up!
I set my rental condo up on a weekly mortgage hoping to benefit from this. Thinking it over again, it probably wasn’t the best plan (its a tax advantaged debt, so why rush to pay down the principal)…
Good post!
Another thing to consider is that if you are paying really low interest on your mortgage, you are probably better off using the money for something else.
Fascinating, I always how those payment plans work. Thanks for this.
I think you had a crappy banker when you took out your first mortgage.
Mine very clearly explained how making more frequent payments worked, calculated what my savings would be if I paid weekly, bi-weekly, twice a month etc. etc.
I chose weekly because (a) once I plan a payment, I find it easy to adjust my cash flow to cover it when it comes through ( b) I will not give a bank a penny more than I have to.
There is lots of information out there that’s very clear. I think you weren’t served very well by the banker or broker you dealt with.
Mr. C – that’s a good question. I guess if you have non-deductible debt then that should get paid before deductible debt. If you don’t have any DD then I don’t know that it’s a bad thing to pay down the mortgage – although Pinyo pointed out, you might have better alternatives.
GIV – you are welcome!
LB – you’re right.
Mike
@ CommanderT and Telly
I specifically asked my mortgage broker and was told that the amounts are exactly the same if I pay monthly or semi-monthly. The semi-annual compounding just tells you that the interest is added to the principal twice every year. But it doesn’t tell _how_ the interest is calculated, daily, weekly or monthly.
It may be that some mortgages calculate the interest daily (at least one does that, see http://www.canadianmortgagetrends.com/canadian_mortgage_trends/2007/09/cts-one-and-onl.html) while others may calculate it on the end of the month.
Duh, I think I may have to read all those documents carefully 🙂
Anyway, according to http://www.mortgagescanada.ca/mortgagepayment.html#biweeklymortgagepayment, the difference between monthly and semi-monthly is small (here they compare bi-weekly and semi-monthly to monthly payments ): “One shaves years off your mortgage payment (bi-weekly); the other barely shaves a month off (bi-monthly).”
Mortgages that accrue interest daily huh?
Sounds like a pretty sweet deal for the mortgage lender. But then it may justify the extra payment plan.
The difference seems terribly negligeable to me. Either you make 4 extra payments/year or you can just save the same money in an interest-bearing account and make one extra payment / year. All in all you’ve spent the same money, so where do you end up? Depends on the interest rate, but the worst case scenario is that you’ve lost the difference of the rates by your extra payments.
If you make an extra $4000 dollars of payments on an 8% mortgage vs. having the money simply invested at 6%, then you end up with a maximum loss of 2% of 4k = $80. This doesn’t factor in the cases where your investments are making more or any intra-year inflationary values.
Really, this whole “extra payments” thing is nothing but a mental tour de force. People don’t mind a little self-inflicted pain as long as they get a break (only once every three months) and they’re achieving their goal (home ownership). The “extra payment” plan is a “make it automatic” strategy for saving, so discussing the numerical savings benefits is really pointless.
I think that Cheap brings up the primary flaw here. Unless you have some seriously deep-seated fear of debt, or really bad saving habits or you feel like the home is a giant weight on your shoulders, then I don’t really see the point of spending today’s money to prevent eventually negligeable payments tomorrow.
If your mortgage payments are seriously stifling cash flow, then buying 3.5 years of “freedom” in 2030 doesn’t sound like the solution to me. In fact, if your mortgage payments are stifling your cash flow, then the last thing you want to do is throw even more money into the same non-liquid investment. If anything you want the cash around so you don’t have to run off and grab a HELOC for cash flow.
OTOH, if you can actually afford the “extra payment” plan, then why not just get a smaller amortization period and simply pay more each time? It’s the same principal, just one step further.
I’m actually a big fan of weekly payments. When I got my (former) condo I barely qualified with my 5% down and a 25 year amortization. By paying weekly I cut the payback period to 20 years and 4 months. Yes, 4 times a year there was an extra payment, but I got paid every 2 weeks, which means that twice a year I’d have a third pay period in the month and the 2 corresponded (the extra pay period and the extra weekly payment). So there were only 2 times a year that I had to come up with “extra” money.
But I couldn’t have taken a shorter amortization period, because I wouldn’t have fit the ratios the banks and CMHC insist on.
Another time when it’s better to take a longer amortization and either pay weekly and/or pay extra is when some of your income is commission or bonus based. Set your mortgage up for what you know you’re guaranteed to be able to pay even during a month when you only get the base pay. Pay more every month that you make the extra money and stick away enough for the dates when the extra payments fall out.
This is a great topic FP because so many people (at least clients I talk to) are confused by the effects of compounding. By way of example, here’s a table with examples of interest savings on a $200,000 mortgage with different payment frequencies (assumes a 40-year Amortization):
Payment Frequency Savings
————————- ———–
Monthly $0
Bi-Weekly $1,638
Weekly $1,948
Bi-Weekly Rapid $93,491
Weekly Rapid $94,180
(Source: TD Payment Comparer)
Cheers,
Melanie
Compound interest rates – fun stuff. The best advice is generally to go talk to the best advisor (leave it to the pros!). A lot of people would be glad to remove interest rates from their vocabulary altogether!
Hi all,
It sounds like you yanks and canadians get the “sharp end of the stick” when dealing with the banks. In australia – or mortages are calculated daily and intrest is charged monthly. – not much different from you, but from what I have read every where on the net, it looks like you have to send your payments through a clearing house each month and then they decide if they will pass them on to the bank, in a timely fashion.
Australians, have total control of their funds, we will make direct debits from our accounts straight into our loan accounts. No second parties – and if we dont like our online banking then we walk into the branch and make the payment over the counter. Hey presto – we are in total control of how the money goes into our accounts and what the daily loan banlance will be!
If i missunderstood what you all have been saying sorry for the post – but I thought I would just share the australian way of banking — and ps, the banks are theives!
Ausie – welcome to the blog. Yes, you did misunderstand – there is no such thing as a “clearing house” or “second parties” – you make your payments right to the bank or whoever you have your mortgage with.
Hrm… weekly payments are going to save me a ton!!! My mortgage is for 40 years @ 4.25. Doing it bi weekly I was going to save $65K (in interest) and weekly $75K because the interest will have less time to compound. 10K over the life of the loan (which going weekly will be cut exactly in half… I will be paid off in 20 years (give or take)). I accounting for the fact I *am* paying extra towards the loan in both scenerios.
My bank doesn’t charge extra for weekly payment. In the weeks where it happens to be five payments, that extra payment is applied towards the main principle.
The author of this article is 100% correct that it makes no difference how frequent your payments are for a Canadian Mortgage. None. Don’t let anyone tell you otherwise.. despite the fact that this CIBC website contradicts me:
https://www.cibc.com/ca/mortgages/already-homeowner/becomng-debt-free-faster.html
Point number 2 starts with the following statement: “You can make payments more frequently which saves you money”
This, by itself, is absoultely false and misleading, and I’ll explain why. The rest of the point read as follows:
“For example if you made accelerated bi-weekly payments of $415 instead of monthly payments of $830, you could save almost $27,000 in interest over the entire amortization period of your mortgage. This would allow you to own your home about 4.5 years sooner.”
This second part could be true only because $415 per 2-weeks does not equal $830 per month! $415 per 2-weeks is actually $902.24 per month. The savings of $27,000 has NOTHING to do with the payment frequency, and has only to do with the payment amount!
I guess if your banker simply told you that if you pay more money, you will pay your mortgage off faster you’d be speechless. Duh!
People that claim there is any benefit related to the frequency of the mortgage payment due to compounding interest are also wrong and I’ll explain:
Every Canadian Mortgage Interest Rate quoted to you is, by law, the effective rate if compounded semi-annually. Read carefully: The ACTUAL Interest rate you will pay on a Canadian mortgage is lower than the quoted rate! Why? Because the rate has to be adjusted to match your chosen payment frequency, which also becomes the compounding frequency of the loan. A monthly mortgage is compounded monthly, weekly is weekly, etc. But regardless of which frequency you go with, you get the EFFECTIVE quoted Interest rate, compunded semi-annualy. Thus there is absolutely no benefit whatsover associated with the frequency of your mortgage payment.
I don’t know how clear my explanation is, but that is the answer.
One last point. When you make a lump sum payment to your mortgage, it always comes out on the “next payment date”. This prevents you from realizing any benefit from compounding Interest savings by making payments more frequently than your payment(and compounding) frequency.
My anger at this whole subject is this is precisely what banks lie about by telling you that you are saving money by paying more frequently when in fact you are just saving more by paying more. I can’t conceive why the banks have overcomplicated such a simple thing.
My mortgage spreadsheet I built to track every payment’s Interest and Principal, including variable Interest rate, payment increases, lump sum payments, etc, has deviated from my bank statement by 3 cents over 4.5 years on an almost $300K mortgage. So I have verified what I am saying with sound mathematics. I do know what I am talking about. Please be informed about this and help educate others, especially the bankers and mortgage brokers who I think simply don’t understand what they are talking about.
Melanie – I checked your numbers at the TD site and that is also based on “Accelerated” biweekly/weekly which means divide the monthly payment by 2 and pay it every 2 weeks. The savings you quote are a result of putting more money on the mortgage over the term and not of the change of frequency. As a mortage broker you should understand this and be honest about it to your clients.
i had a terrific mortgage in the UK through Virgin. it was a Virgin One account – the mortgage account was directly linked to your current account ( checking ) – so all the time you have wages in there it reduces the daily interest payable on your mortgage account. the savings were great.
I am doing some research on this topic and I was wondering if you save any money or if there is any benefit to paying your monthly mortgage payment early every month. Since interest is calculated daily, if I consisently pay my mortgage on, say April 15th instead of May 1st, for every month, will I save money by lowering my interest payment? (My bank won’t allow me to make partial payments, so I figured if I paid it the monthly payment in full, two weeks early every month, I’d save some money over the life of the loan.) Thanks.
Wow this is a really interesting article guys.
@Grubby – any chance you could share your mortgage spreadsheet? I’ve tried setting something up, but the payments I calculate in EXCEL don’t match up with reality.
So I have 2 questions.
First seems pretty basic but yet I don’t understand it.
If I owe someone $1000 and they charge me 1% interest monthly, compounded monthly, then for the 1st month I’d owe a total of $1010 ($10 interest). So if I pay $110 that month, then for the second month I’d only owe a principal of 900$, and then the second months interest would only be 9$! Its decreasing! So then in the second month I’d pay only 109$. Third month; owe $800 principal + 8$ interest, so I’d only pay 108$. … The point is my cash flow is improving as I pay down my loan (payments are getting less), SO why doesn’t this happen with mortgages? And as far as I can tell for mortgages, if I make extra payments I would see no improvement in my cash flow/reduction in my mortgage payments (assuming interest rates staying the same) ever, until the time that I actually finish paying off my mortgage. Which means I’d likely have to wait 15, 20, even 21.43 years before seeing the benefit of paying extra into my mortgage. Whats wrong here?
Second question.
Would it not be better to save up any ‘extra payments’ you might pay into your mortgage, until the end of your mortgage term, and pay the saved up money into your mortgage at the end of you term. That way you’d gain the investment interest on your cash in the mean time (instead of the bank getting it)?
And for that matter, wouldn’t it be better to amortize your mortgage for 25 years instead of 20 (if your were going to choose 20 originally), and put the extra money per month your saving into an investment/GIC and earn interest. Then you’d dump it into your mortgage at the end of every term (5 years say). Cash flow wise this would be the same as having a 20 year amortization instead of 25, but you would gain investment interest on the payment differences (assuming you could be disciplined enough to save and invest it).
Thanks in advance.
hi john v. i will email you my spreadsheet. by the way, it turns out i am wrong that the difference is zero, but it is small like others said.
Ok to answer your two questions, if I understood them right…
1. In your example, this what actually happens: You got it right up to month 2 with 900$ principal. What happens is your $110 payment now goes 9$ to interest and 101$ to principal so next time it will be $799.
my way principal interest payment
january $1,000.00 $10.00 $110.00
february $900.00 $9.00 $110.00
march $799.00 $7.99 $110.00
april $696.99 $6.97 $110.00
may $593.96 $5.94 $110.00
june $489.90 $4.90 $110.00
july $384.80 $3.85 $110.00
august $278.65 $2.79 $110.00
september $171.43 $1.71 $110.00
october $63.15 $0.63 $63.78
total $53.78 $1,053.78
your way principal interest payment
january $1,000.00 $10.00 $110.00
february $900.00 $9.00 $109.00
march $800.00 $8.00 $108.00
april $700.00 $7.00 $107.00
may $600.00 $6.00 $106.00
june $500.00 $5.00 $105.00
july $400.00 $4.00 $104.00
august $300.00 $3.00 $103.00
september $200.00 $2.00 $102.00
october $100.00 $1.00 $101.00
total $55.00 $1,055.00
2 things happen:
1- you pay off the loan faster (in this example you’d still have 10 payments, but last payment would be smaller)
2- the total interest you’ve paid will be less at the end, so you saved money.
so, your cash flow doesn’t improve with each payment, but the effectiveness of your payment increases each time (less interest, more principal). With a mortgage, the extra dollars pay off big time over the life of the mortgage.
In your method, the balance decreases in a straight line. With mortgages the decreases get a little bigger every payment.
Question 2. Every mortgage payment day they do this:
1. Multiply your balance by the interest rate per pay period.
2. Add the interest to your balance.
3. Subtract your payment.
(repeat next payment date.)
So if you pay an extra 100$ on your next mortgage payment, your balance will be $100 smaller the next time step 1 comes around. The interest savings will compound for the term of your mortgage. If you hold that $100 until the end of the term and pay it, your balance afterwards will be bigger. You would have to have invested that $100 and earned a return that is equal to the mortgage interest rate, then put the $100 + earnings (which are taxed) on your mortgage just to break even. The only way investing your money instead makes sense is if your rate of after-tax return is higher than your effective mortgage interest rate.
Hope I answered your questions ok 🙂 you can email me for the sheet…
grubby_d (at yahoo dot com).
rye mom
When you make an extra payment, tcomes out WITH your next payment. In Canada at least,they do not let you pay mid-month on a monthly mortgage.