When borrowers are approved for a home loan, lenders generally default your repayments into a monthly payment cycle, rather than weekly or fortnightly which, on face value, seems ok to most people. Much of a muchness right?
Wrong! Once you factor in that pesky compound interest, your home can end up costing you way more money (like tens of thousands) and delay the time it could take you to pay off your loan if you go monthly. Compound interest is the interest you pay or earn on interest on a principal amount over time.
Compound interest is fantastic when it comes to your superannuation or savings. Your savings earn interest and then as time goes on, you make interest on the interest. In home loans, it is a bit less awesome (ok - a lot less awesome)!
If you pay your mortgage repayments weekly or fortnightly, you are paying down the principal amount faster, and thus reducing the interest that will accumulate. Interest is calculated on the principal balance, so with less principal owing, there’s less interest payable.
However, just to throw you as you are getting your head around this, lenders have two ways of calculating weekly or fortnightly repayment amounts.
Some charge a fortnightly payment amount as the total annual repayment amount divided by 26 fortnights. And there are savings in this method, but considerably less than the other way of calculating. So while it will shave some time and money off your loan period, it won’t be as much.
The other method to calculate is to take your monthly repayment amount and divide it by two, paying that amount fortnightly. Due to calendar months not being a strict 28 days (four weeks), the net result is monthly payments are calculated on a higher number of days, so paying more frequently means you pay more money off the principal than if you paid monthly.
The key learning here is to pay off more than your minimum repayments to reduce your interest and cut the time you are locked into your mortgage.
Apart from that, many of us are paid weekly or fortnightly, so it makes sense to fit the repayments into your regular budget calculations as well.
If you're already stuck in a monthly repayment cycle, you will need to check whether your lender offers you the flexibility to switch to fortnightly or weekly. Not all lenders or home loan products have that flexibility. If you are just starting on your home ownership and mortgage journey, it is worth investigating if your preferred lender has weekly and fortnightly repayment options.
If your lender offers various payment frequencies, be sure to ask them how they calculate weekly fortnightly payments. As you can see from the table above, it will take thousands and years off your home loan using the second method.
Check if they will charge fees to make the switch. And you could ask them for an interest rate cut while you are at it. After all, if you don’t ask, you don’t get.
If your lender is inflexible and has you locked into more expensive monthly payments, look around for someone else.
Reproduced with Permission from Athena Home Loans.