Puff the Magic Payment Frequency

There is a stubborn misconception out there that changing the frequency of your mortgage payment, as if by magic, will knock years off your amortization period. Let’s put this belief to the test.

Assume that you have a $300,000 mortgage with a 25-year amortization and a 5% interest rate which you pay monthly. Your total interest paid over 25 years will be $223,445.97.

If you change your payment frequency to weekly and leave all the other characteristics unchanged, your total interest paid over 25 years will be $222,619.70.

That saves you $826.27 over 25 years. Or $33.05 a year. Not a lot of magic there.

So why does this misconception exist?

I blame the marketers.

Several years ago some bank’s marketing department was looking to add a little sizzle to their mortgage steaks and came up with the option for “accelerated” payments.

Here is how a comparison of they work compared to regularly monthly and bi-weekly mortgage payments using the same $300,000 mortgage at 5% with a 25-yr AM:

• Regular monthly payment = 12 payments of $1,744.81, which adds up to $20,937.72/year.
• Regular bi-weekly payment = 26 payments of $804.41, which adds up to $20,914.66/year.
• Accelerated bi-weekly payment = 26 payments of $872.41, which adds up to $22,682.66/year.

A borrower who chooses the accelerated bi-weekly option is paying half of the monthly payment every two weeks.

By making that payment 26 times, instead of 24 times, the borrower is making the equivalent of two extra bi-weekly payments each year.

I think misunderstanding occurs because the bank’s marketing material can give borrowers the impression that increasing their payment frequency alone will meaningfully accelerate their principal repayment.

As the example above illustrates, an accelerated bi-weekly payment reduces your mortgage balances faster because you are paying more, not because you are paying more frequently.

On that note, mortgage borrowers who want to pay extra can do so via accelerated weekly or bi-weekly payments. But they can increase their mortgage payments in myriad other ways. For example, by rounding to the nearest $100, by increasing the mortgage amount so that it accounts for 32% of gross income, or by rounding up to 87 because Sidney Crosby is your favourite hockey player.

When it comes to your payment frequency, I offer one simple suggestion. Match the timing of your mortgage payment to the timing of your paycheck. That way, your mortgage payment will be taken before you wake up in the morning and you will never have to worry about being short.

As for prepayments, the more you pay, the faster you will be mortgage free.

To conclude, the frequency of your mortgage payment won’t have much impact on your mortgage principal over time … except maybe in the land of Honilee.