Bi-monthly payments to reduce interest?
A good friend of mine who has run her own business for many years and I were chatting over the weekend, and she shared with me one of the ways to cut interest is to make bi-monthly payments instead of paying the total amount due in one payment per month. She pointed out for loans that compound the interest daily paying half of the payment in the middle of the month reduces the total principle by just a little bit, but it's enough to put a small dent in the total over time all the while never paying a penny more than the minimum amount of the payment required.
Has anyone done this? Does anyone know how to calculate the savings over the life of a loan by doing this?? Very curious to get an idea of how much impact this could have for us.
farfromtheusual Hi there! Yes, anytime that you can make additional payments or earlier payments, then you can save significant amounts of money. One of the best ways is to make bi-weekly payments if you can because you will make 26 payments which is the equivalent of one extra month. It uses the same principle as getting the extra payday. There are tons of calculators out there. My sister just introduced me to one that is offered by the Canadian government. I like it because they are not trying to sell me anything unlike ones from the bank etc. And I don't have to worry about privacy concerns with shady calculators.
I am going to provide two links. The first one is one that offers lots of different calculators and information. The second is a specific one that helps you to calculate savings from different payment options on debt. It was fabulous. These will work regardless of currency.
https://itools-ioutils.fcac-acfc.gc.ca/FGC-COF/home-accueil-eng.aspx - click on the "get out of debt" on the lower left
Once you have entered the information and save it, there will be a "Details" tab. Click that and it will tell you how much interest you will pay over that time. Edit and change the payment frequency. I just did it for one of my cards. Monthly, I would pay about $1300 in interest. Changing to twice a month (bi-monthly) made the interest $642 and bi-weekly makes the interest $591.
Hope this helps!
For interest that compounds daily or is calculated on average daily balance, it's always best to make a payment as soon as you have any money to make the payment available. The longer the balance is lower, the less interest. The reality is that the debt servicer may have limits on payment frequencies, so a regular cadence within that context may be appropriate.
When interest is calculated on a final monthly balance, such as a mortgage payment, when you make the payment or extra principal payments doesn't matter (beyond late payment dates) as far as interest reduction.
Assuming a mortgage, most of the gains are due to simply due to throwing more money at the loan. If the monthly schedule is $1200 per month, but you switch to paying $600 every two weeks, you will actually pay a total of $15,600 instead of $14,400 -- an increase of 8.3%, which is pretty substantial.
Similar gains will be had from making 12 monthly payments of $1300 (=1.083*1200). No magic involved.
Furthermore, the timing is important. For example, MORE interest will accrue with this particular bi-weekly payment timing compared to the equivalent monthly amount (i.e., for the same total yearly outlay):
- Bi-weekly might get 1200, 1200, 1200, 1200, 1200, 1800
- Monthly might get 1300, 1300, 1300, 1300, 1300, 1300
In some countries, mortgages accrue interests daily (e.g Australia) so make sure to check with your bank or your loan agreement to know which category your mortgage falls into.
Thanks for everyone for your thoughts!
My thought process was to pay twice monthly, more than likely on a 1st/15th schedule because I can keep up with that easily since I get paid those days. I will have to call the mortgage company and find out how the interest is calculated to see if it makes a difference to make the partial payment early or not. I'm thinking it might be worth it to check in with the car loans, too, to see how they are calculated and whether or not spreading the payment out over the month would help with the interest there as well. I don't mind going in and doing a little more work to make extra payments if it saves me a few dollars! Last month when I paid the interest on my credit cards the day after it hit, it saved me $5 the next month in interest, so there's that!
I've heard people talk about doing this as well, so we tried semi-monthly. The idea was that, if we got half a month ahead in our payments, then the first payment of the month could go towards the principal and have longer reaching interest effects.
However, that was just not the case. The mortgage company wouldn't apply the first half-payment until they received the second half-payment. I thought it was because the portion of our payment going to the principal was less than half of the payment, and if we self-escrowed then maybe that tactic would work.
This provides a better explanation, though.
I mean we got the benefit of a lower balance because of the one-time extra half-payment to get the ball rolling, but now there's no reason to split it up.
Move Light Sound Life said:
I've heard people talk about doing this as well
The main reason it "works" (assuming the lender lets you do it) is because people are comparing apples and oranges. Biweekly simply throws more money at the loan per year than a standard monthly payment. When comparing apples to apples (biweekly vs. 1.083*original monthly pmt), the 8% larger monthly payment comes out ahead because of the timing.
It definitely makes a difference! My mortgage & HELOC payments have always been bi-weekly and I've changed them to weekly. It makes no difference to me using YNAB since I just budget the 2 week amount when I'm paid (or more to get buffered) and it is withdrawn weekly. It pays down your loan faster! :)
First of all, I HATE debt but I can't justify putting an extra penny into my mortgage anymore. Every time I explore it, I come to the same conclusion. For me, it would just be tying up funds that I could have invested instead. If I were planning on staying in this house, it might be different, but I'm not. Also, my mortgage is so big due to my living in a HCOL area, that I wouldn't be able to even pay it off before I sell the house. All extra mortgage money would do for me is tie it up and give me a small reduction in interest paid over the next five years until I got it back in the sale of the house. I much prefer the liquidity and leaving it parked in the market. I will never be forced to sell it at a loss. I can pretty much guarantee it will make more than the 2.875% mortgage I'm paying which brings me to my best bet which is to just get the mortgage rate down to the lowest possible amount until I sell the house. I may be there now with my latest refinance but who knows with the 0% fed rate of these times.
I've started putting extra in many times but always realize it's not my best move. I was at least rounding up the payment to the nearest 100 before I refinanced. I don't even do that anymore as it goes against all my financial principles.