I had a query from a client recently on whether she would save money by making her mortgage repayments fortnightly rather than monthly. The answer is yes but the effect of this has been greatly exaggerated by many media articleâ€™s, some of which miss the point a bit. You will make a small saving by making fortnightly repayments but the amount you will save will be very low unless it results in you making more repayments each year.
If you take a â‚¬400,000 mortgage over twenty years at a rate of 4.5%, the monthly repayment will be â‚¬2,530.60.
The total repayments will be Â Â Â Â â‚¬607,344.00
And the cost of credit will beÂ Â Â Â Â â‚¬207,344.00
If you repay the same mortgage by bi-monthly repayments the repayment amount works out at â‚¬1,264.57.
The total repayments will be Â Â Â Â â‚¬606.993.60
And the cost of credit will beÂ Â Â Â Â â‚¬206,993.60
You have saved a total of â‚¬351 over the twenty year term so itâ€™s not substantial.
The reason that you make any saving at all in this scenario is that Banks calculate interest based on the balance outstanding on your mortgage each day. If you consider the first month of the above mortgage, the interest which accrues in month one is less because you have paid a little of the principal after only two weeks so for the second half of that month your interest bill is based on a slightly lower principal amount.
Real savings can only be realised by taking your scheduled monthly repayment amount, and paying half of this amount against your mortgage every fortnight, rather than twice a month â€“ there is a difference.
If you contact your bank to arrange switching your repayments to fortnightly, the chances are that they will offer you the option of changing to twice a month rather than fortnightly. If you make your repayments twice a month, say on the 1st and 15th, you will still only make 24 repayment each year, however if you make half of your scheduled monthly repayment, every two weeks, you will end up making 26 repayments each year. The saving comes from making more repayments (and therefore repaying more of your mortgage) each year. If applied to the above example, you would end up paying off your mortgage over two years early.
The answer to this is that unfortunately, like a lot of things which seem too good to be true, so is this.
Comments in this blog are general in nature and should not be taken as financial advice as no assessment has been undertaken in relation to your financial situation or objectives.