The power of automating your finances
In a previous post, I discussed the power of automating your financial life. In today’s post, I want to discuss a very specific application of that concept to help you knock a few years off your mortgage with almost no effort.
It is as simple as deciding how you want your mortgage payments to be structured. The most common payment frequency for mortgages in North America is a monthly payment. Most people are comfortable with monthly mortgage payments as they have already been trained to pay their living costs through monthly rent payments.
Another common payment frequency is bi-weekly. Some people like this because they are paid on a bi-weekly basis so they can line up their mortgage payment with payday.
Personally, my wife and I like this payment frequency because we split our mortgage payments 50/50. I'll get the first mortgage payment of the month and she will take care of the second payment of the month. This makes it easy to track “Who’s mortgage payment is next”.
How mortgage payments work
A typical bi-weekly payment does not necessarily help you pay off your mortgage quicker. Before I jump into the math a little bit let's remember that there are 52 weeks in a year so that means 26 bi-weekly payment periods in a year compared to 12 monthly payments in a year.
Let’s say your monthly mortgage payment was $1,000 per month or $12,000 per year. A bi-weekly payment would be calculated to total $12,000 per year as well. So, in that case, your bi-weekly payment would be $461.54 ($12000/26). With a bi-weekly payment, on most months of the year, you will actually pay less than you would with a monthly payment.
In the above example, if you have 2 bi-weekly payments of $461.54 your total for the month would be $923.08 which is less than $1,000. The “catch” is that since there are 26 bi-weekly payments a year, you have 2 months out of the year where you have 3 payments. In those months you would pay a total of $1,384.6.
It all balances out over the year.
One Simple Change to Knock Years off Your Mortgage
OK, now that part I promised where you can knock years off your mortgage with One little “Set it and forget it” change. Ask your lender if they allow you (without extra charge) to set up what is called an “Accelerated” bi-weekly payment frequency.
Accelerated bi-weekly payments are actually pretty simple, it works as follows: cut your monthly payment in half and pay it every 2 weeks. That’s it.
In the above example where the monthly payment was $1,000 and the bi-weekly payment was $461, the “accelerated” bi-weekly will be $500. Most months of the year, you won’t notice a difference compared to the monthly payment. But for 2 months of the year, you will have an extra $500 payment, which adds up to a whole extra monthly mortgage payment every year! You might be asking will one extra monthly payment really make a difference?
Let’s look at an example and find out (spoiler it does).
Let’s say you have a $400,000 mortgage at an interest rate of 4%
If you choose a monthly payment frequency and a 25-year amortization you will have paid your mortgage off in 25 years and paid $231,224.25 in total interest over the life of the mortgage.
If you choose “Accelerated bi-weekly” you will have paid off your mortgage in 22 years and paid $198,495.62 in interest.
If my math is correct that knocks 3 years off your mortgage and saves you $32,728.65 in interest! Not bad for one extra payment per year! The power of automating your financial life in practice.
This article is for informational purposes only, it should not be considered Financial or Legal Advice. Consult a financial professional before making any major financial decisions.
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