If you have a home loan, I’d be very surprised if you haven’t heard from a myriad of sources saying that you need to be making weekly or fortnightly repayments, as opposed to monthly. You’ve no doubt heard the many messages bandied about how weekly or fortnightly repayments can save you tens of thousands of dollars in interest and years off your mortgage.
For as long as I’ve been in the business, ‘monthly’ has always been the standard default repayment cycle required by the banks, although they will allow you to make weekly or fortnightly payments.
What I want to share with here is that making monthly repayments is still quite okay, and I want to explain why.
But to get to my reason, it’s important that you first understand some basics.
To start with, how do the banks get their interest from you?
Interest is calculated on your loan every day. So every night whilst you sleep, the banks computer systems determine how much they are going to bill you for using their money. They come up with a daily rate of interest, which is determined by your annual rate divided by 365. Therefore if your interest rate was say 4.50%pa, then dividing this by 365 = a daily rate of 0.01232877%. If your loan balance at the end of the day was $300,000, then your daily interest cost would be $36.99. The banks accrue this daily interest cost over the course of a month before finally charging you. That’s why each month you’ll see an interest debit to your loan resulting in an increase to your loan balance.
What the banks expect from you is to pay back what you borrowed, along with paying for the cost of using their money, which I have just demonstrated is something they calculate on a daily basis.
Now it’s not rocket science to realise that the quicker you can get your loan balance down the less interest you are going to be charged. How you achieve this is determined by how much you pay to your loan.
The myth I want to bust here is that it’s not the frequency of your repayments, but rather the amount that you repay that is going to make the difference.
When you hear the claims about weekly/fortnightly repayments saving you so much, it’s because the numbers they are working with are being misused. The classic example of this is when your monthly loan repayments of say $2,000 should be paid fortnightly at $1,000. What is often neglected to be pointed out is that your annual repayments ($2,000 x 12) are $24,000, and if you pay $1,000 every 14 days your annual repayments ($1,000 x 26) equate to $26,000, which is essentially paying an extra $2,000 in repayments per year. So when you halve your monthly repayments this way and pay every fortnight, all you are essentially doing is paying the equivalent of 13 months payments per year.
It is acknowledged that the more frequently you make a payment the less interest you will be charged (due to daily calculation of interest), and yes this does make a slight difference over time but is not significant in my opinion. Your focus should be on how much extra you can pay – not the frequency.
I’m not trying to defend monthly repayments here and suggest that’s what you should be doing. I just want to highlight that the comparisons often used on repayment frequencies are regularly taken out of context. So the message I’m trying to deliver is that you can still achieve similar interest savings and reductions in your loan term via monthly repayments provided you pay the extra off your loan (which is $2,000pa in the example used).
My advice is to make your loan repayments in line with when you receive your income. With most people being paid weekly or fortnightly, this suggests that most of you should be paying weekly or fortnightly.
If you live from pay period to pay period, the best you can do is to make your loan repayments as soon as your pay hits your bank account. You cannot do any better than that!
Taking your monthly repayment and dividing it by 2 or 4 is surely a way of forcing you to make some extra repayments, and could be a better system if you lack the discipline to make the extra repayments over time in other ways.
I hope this makes you aware that it’s not whether you make weekly, fortnightly or monthly repayments that determine how much interest you can save. It’s how much you pay that is the all important factor.
“There is no magic formula for getting out of debt quicker.
It’s just a combination of getting the best interest rate you can
and making as much as you can afford in extra repayments.”
If you’d like to receive a complimentary review of your loan to determine if you are getting the right rate, I’d love to hear from you.
Cairns Mortgage Broker – Jason Thomson is a Mortgage Adviser and Finance Broker based in Cairns with clients all around Australia. Client reviews featured on his website prove that Jason is a trusted industry professional, facilitating great outcomes for his clients. Using his wealth of experience in financial services, he thrives on delivering superior service. Jason is very approachable and is always looking for new clients to help in the often confusing world of finance and property. Offering a no fee service, you’ve got nothing to lose by having an obligation free chat with Jason today.