Many Canadians know that biweekly mortgage payments pay off their mortgages faster. But do you know why? Are all biweekly payments equal? Are there any downsides?
Let’s break it down!
It’s a common misconception that biweekly payments pay off your mortgage faster because you are paying down the debt every two weeks rather than once a month. The idea is that the higher payment frequency counters big bad “compound” interest and puts the borrower ahead. Sadly, like many financial myths… it’s one part truth and 99 parts misconception.
Case Study
I want you to imagine three brothers, Tom, Dyck and Harry purchase three identical homes. Each secures a $100,000 mortgage and gets a rate of 4%.
Tom doesn’t care, its going to take FOREVER to pay off his mortgage so he makes monthly payments.
Now Dyck knew that he was smarter than Tom, he had read somewhere that biweekly payments were better… something about paying down the debt more often. Dyck takes out his calculator works out a year’s worth of payments and divides the number by 26 (biweekly payments per year). He decided on 26 biweekly payments per year.
Finally Harry makes his decision. He chooses biweekly payments equal to half of the monthly payment.
Who do you think will come out ahead? Who will pay the least interest? Will someone pay off there mortgage faster?
Lets look.
Analysis – Biweekly Payments and their impact
Tom, making monthly payments of $477.42 pays off his mortgage in 30 years with a cost of roughly $71,869.60 in interest over 30 years.
Dyck, making biweekly payments of $220.24 pays off his mortgage in 30 years. Dyck paid roughly $71,790.12 in interest over 30 years.
Harry, making accelerated biweekly payments of $238.71 pay off his mortgage in 25.88 years. Harry paid roughly $60,592.39 in interest over 25.88 years.
Over the life of the loan Dyck saved about $79.6 by making biweekly payments whereas Harry saved $11,277.21 by making accelerated biweekly payments.
How does paying off mortgage faster relate to you?
If you make accelerated biweekly payments you can save tens of thousands in interest while also paying off your mortgage years faster!
Learn more about the types of variable rate products and how to reduce your cost by 24%
How do biweekly payments pay off your mortgage faster?
Accelerated biweekly payments pay half your monthly payment twenty six times a year. This works out to paying thirteen monthly payments a year.
But Keaton I am paid monthly, there is no way I can make three mortgage payments two months of the year!
I have a solution for you! Increase your monthly payments by 8.34% and you will have almost an identical result as making accelerated biweekly payments.
Let’s take a look.
Tom’s monthly payment was $477.42, if he increases is by 8.34% he would pay 517.24 per month.
This increase means his mortgage would be paid off 4 years faster and he would save over $11,130 in interest.
Increasing your monthly payments by 8.34% is the same as making accelerated biweekly payments without the hassle of making 3 biweekly payments two months of year (for those paid monthly). You are making the same total payments per year, its just broken down over twelve payments or twenty-six.
This is great! Are there any drawbacks?
Clients interested in Real Estate investing and those who wish to maximize their qualifying power should avoid accelerated biweekly payments as well as locking in payment increases.
By making accelerated biweekly payments you increase your total payments per year by 8.3%. This really matters for investors who want to buy multiple rental properties as it increases your total debt servicing. Ultimately this can be the difference of qualifying for investment properties as your portfolio grows.
What do Scott and Keaton recommend?
For our clients who have no interest in real estate investing we highly encourage accelerated biweekly payments or increasing your monthly payment 8.34% (or more if you can budget it). **reference budgeting article and encourage creating a budget** If you goal is a better retirement we suggest investigating the Smith Manoeuvre in combination with accelerated biweekly payments.
For our clients interested in Real Estate investing we strongly advise avoiding payment increases and accelerated biweekly payments.
Instead, we advise our clients to make monthly payments and to use pre-payment privileges to prepay one extra monthly payment per year. This benefits from virtually all of the benefits of accelerated biweekly payments while having none of the qualifying drawbacks.
At Kirkwood & Brennan we focus on providing you with sound financing advice based on your long-term goals. We view our role as that of advisors or guides, we want to educate and empower you so that you can decide what solutions work best for your situation
