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.
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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://www.canada.ca/en/services/finance/tools.html
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!
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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
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dakinemaui I'm not sure what you mean by "more interest will accrue with this particular bi-weekly payment timing..."
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farfromtheusual for monthly compounding, the balance is less each month for the monthly payment.
My point is timing is important. Biweekly payments are not always going to be better.
Even compounded daily, a $1300 monthly payment on the 1st vs a $600 biweekly payment starting on the 1st will have a lower average balance and therefore less interest.
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nolesrule said:
When interest is calculated on a final monthly balance, such as a mortgage payment,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.
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Ceeses thanks for pointing this out. My friend implied that the mortgages were calculated daily, not monthly, so we'll have to call our company and find out how they do things. I'm all in favor of making my money work a little harder for me!
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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!
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farfromtheusual I can't remember if you are in the U.S. or not, but all U.S. mortgages are the same with interest calculated on the monthly balance.
If it wasn't then paying a mortgage late but still during the grace period would lengthen the mortgage (so would paying very late, but that incurs extra fees), and paying even a day early would shorten the mortgage.
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nolesrule thanks!
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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.
nolesrule said:
all U.S. mortgages are the same with interest calculated on the monthly balance.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.
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Now, when I was paying my student loans, they compounded interest daily, so you'd THINK paying semi-monthly would benefit me. However, they changed the game with three rules.
1. I was required to pay a minimum monthly payment, and any payment received during their month counted towards that monthly payment's requirements first.
2. The minimum monthly payment was allocated first to any fees, then interest accrued, then spread among my loans proportionally as decided by the loan company (if loan A was 50% of my total loan amount, then loan A would get 50% of what was left of my payment after taking care of interest). Also, any extra payments were first required to zero out the interest before affecting the principal.
3. Because I enrolled in auto-pay (for that interest rate reduction), my monthly cycle that determined when my payment fulfilled the interest requirement started over the day after the auto-pay.
So, if I had an extra payment ready halfway through the month, it was more beneficial to schedule it for the same day as my regular payment. None of it would go to interest or be allocated proportionally, and I could tell the company to put the entirety of the extra money on the loan with the highest interest rate/balance.
Sure, paying the extra payment at all decreased my loan time, and the timing didn't matter when my entire payment went to interest anyways. But, there was more power to my extra dollar on one day and not the next once I had access to my principal amount.
I don't think credit cards have such restrictive rules, but I'm pretty sure they compound interest daily.
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Move Light Sound Life 🙄 Good grief, that's annoying. Yeah, it totally doesn't make sense to pay anything extra. I wish they weren't allowed to do things like that, they're already making money hand over fist, and putting such crazy rules in place only keeps more dollars in their pockets, which is so frustrating.
And yes, I don't think that the credit cards have such restrictions, so that would have benefit in paying early/more often. I'm going to have to double check our auto loans and find out how those work to see if that might help, too.
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Move Light Sound Life said:
I've heard people talk about doing this as wellThe 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.
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dakinemaui Additionally, people should be reminded thatevery two weeks vs. twice a month is not the same thing.
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dakinemaui that's why I said bi-monthly. I don't intend to make extra payments, my only intention was to split it up and pay it twice a month instead of once a month. I can see why doing it bi-weekly would contribute more money but only because I paid more towards principle than required, not because it actually reduced the amount of interest accrued while paying only what is required.
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farfromtheusual Fingers crossed that the compounding and whatever restrictions are in place will allow an earlier payment to make a difference for you.
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farfromtheusual This comment caught my eye because it was different from what i envisioned. In my scenarios that I brought forward, the payment terms (monthly, bimonthly, biweekly, weekly) are actually part of the loan agreement and that is how it will be paid. In most Canadian major banks, mortgages have the following options available in some form:
1. Accelerate payment from a monthly to other options such as bi-monthly or bi-weekly. These are then part of the loan and cannot be changed without renegotiating the mortgage.
2. Monthly pre-payments. Each one varies but you can add from a small dollar amount ($100 usually) to a double payment for either one, some or all months. Pre-payments go directly to principal and interest.
3. Annual pre-payments. Normally can make an annual pre-payment of up to 10% of the original principal amount of the mortgage. This option is frequently tied to closed rate mortgages.
You may wish to investigate if these options are available to you as well. Here links to two Canadian bank that explains it. I tried looking up US based information and got quickly overwhelmed. I think it is much more consistent across Canada here.
https://www.cibc.com/en/personal-banking/mortgages/resource-centre/prepayment.html
https://www.rbcroyalbank.com/mortgages/pay-down-mortgage.html
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Navy Blue Pegasus Thanks!! And yeah, I'm sure things in the US are infinitely more complicated than they are there. 🙄
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farfromtheusual Every country has advantages and disadvantages. 🙂
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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! :)
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Purple Foal Why not pay the entire 2-week amount upfront then?
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Purple Foal It only makes a difference if your loan has daily compounding interest or it's calculated on the average daily balance.
Which is why I try to remember to always mention that it doesn't matter specifically for a typical U.S. mortgage. Sure, the balance will go down weekly, but it doesn't change the interest calculation... for U.S. mortgages. -
nolesrule Very true. My mortgage and HELOC have interest calculated daily. By increasing my payments, I am reducing the interest. :)
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dakinemaui Paying every 2 weeks means that once a payment is made, interest is calculated daily on the remaining balance. By paying weekly, more of the payment is applied to the principal. For example, I pay $123.77 each week. I reconcile my loan in the tracking area of YNAB and it will make the adjustment for $111.45 which means I paid about $12 interest that week (why I'm attacking that loan). But as the weeks go by, I've noticed that the adjustment gets higher to $112 or $113 as I make more payments and snowball payments. As the balance goes down, so does the interest. There is a tool next to my loan online which says if I made a $500 prepayment, I will save $50 interest & pay off my loan 2 months sooner (example). So the more payments you make, both regular payments & snowball), the better. :)
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Purple Foal You're missing my point.
You have money available to send to them but only send half of it. Since interest is compounded daily, holding onto that second week's portion doesn't make any sense.
Given your income schedule, you would be better off (pay less interest) by paying bi-weekly.
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dakinemaui I pay the accelerated weekly payments. It works out better in the end.
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Purple Foal
Biweekly is calculated: monthly amount x 12 /26.
Accelerated biweekly: monthly / 2 so this amount will be higher for the 26 payments
Accelerated weekly: monthly / 4 so this number will be higher for 52 payments
The more payments you make off the principal, the less interest over the course of the mortgage. :)
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Purple Foal and it will still be better if you give them the entire amount you budgeted when you budget it rather than hold half of it for a payment the following week.
The sooner you pay, the less interest is incurred.
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dakinemaui I'm not sure that is the case. Since I've switched to accelerated weekly, vs accelerated biweekly, I can see the number actually coming down when I'm watching my HELOC that I am attacking.
Check out the info on the website.
https://www.rbcroyalbank.com/mortgages/accelerate-mortgage-payment.html
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Purple Foal I'm positive that is the case when interest compounds daily. However, you seem satisfied with your current arrangement, so you might as well carry on.
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FWIW, the savings of what I'm talking about over accelerated weekly is comparable to the jump from accelerated bi-weekly to accelerated weekly. Roughly $250 in interest saved over "accelerated weekly", so you're not being penalized much.
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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.
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Superbone This perspective isn't mentioned as often! Glad you brought it up.
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Superbone A good point. Once my HELOC is clear, and I have bought out my car lease, I will be focusing on taking the money I have been paying towards debt to both my investments and attacking my mortgage. I don't plan to sell anytime soon and I want to be mortgage-free when I retire. :)
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Purple Foal I too will be mortgage free when I retire. I plan to pay cash for my retirement house. Just for cash flow purposes alone, that will be nice. It doesn't matter how you get there but just that you get there.
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