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Mortgage repayments: fortnightly or monthly?
What you've been told might not be strictly accurate.
Many people believe that fortnightly repayments are a better option than monthly repayments, based on a simple premise.
The idea is that with fortnightly repayments, you pay two extra repayments per year, and by halving the monthly repayment figure and paying it fortnightly, you'll pay your loan off much faster and save thousands in interest. Sounds great, right?
Without proper analysis, this seems to be a great idea. However, after crunching the numbers, we see a flaw in this theory, which we’re labelling the ‘Fortnightly Fallacy’.
The Fortnightly Fallacy
We found the following statement on a major NZ bank’s website: “If you currently make monthly repayments on your loan, you could pay half that amount each fortnight instead, meaning you make two extra repayments per year – this reduces the amount you owe and you’ll pay less interest on your mortgage too.”
The same bank goes on: “Based on the example above, on a $250,000 home loan at 4% p.a. for an initial term of 30 years, paying half your minimum monthly repayment each fortnight could save you over $28,000 in interest costs and you’d pay off your loan 4 years and 2 months earlier.”
The maths adds up, but the bank isn’t giving us the full picture here. Firstly, to make the above savings on your home loan you don't need to change the repayment frequency. Changing from monthly to fortnightly repayments simply acts as a smokescreen for effectively increasing your repayment amount. In other words, regardless of whether you make weekly, fortnightly or monthly loan repayments, if you increase the amount you’re paying, you still achieve the same results of paying your loan off faster and saving thousands of dollars in interest repayments.
Here’s the secret. Many people, when asked if they are happy to pay half the monthly repayment amount on a fortnightly basis, will often say “yep, makes no difference to me”, because their brain tells them that there are two fortnights in every month. Not correct of course. Mathematically there are approximately 2.165 fortnights in each month on average. By paying half the monthly amount per fortnight they are effectively being ‘tricked’ into increasing their loan repayments from the minimum to a higher figure. There’s nothing wrong with increasing your repayments, as long as you can afford it. But you don’t need to change repayment frequency to achieve great results.
Let’s look back at the wording that the bank used: “If you currently make monthly repayments on your loan, you could pay half that amount each fortnight instead…”. We now know that this is just an under-the-radar way of them getting us to increase our mortgage repayments - not just the frequency as they’d have you believe, but the payment quantity as well.
Using the bank’s example above, let's say our client, Bob, has a $250,000.00 home loan at 4.0% over a loan term of 30 years, which would require repayments of either:
$276.00 per week, or
$551.00 per fortnight, or
$1,194.00 per month.
Believers in the ‘Fortnightly Fallacy’ would say that $1,194.00 per month divided by 2 = $597.00 and if you pay that amount per fortnight you will save $28,313 in interest payments and reduce your 30-year loan term down to 25 years & 10 months. Again, sounds good so far. But here’s where we lift the curtain on this magic trick: by paying $597.00 per fortnight you have effectively just increased your minimum repayment amount which will, of course, mean you pay your loan back faster. This will make more sense in the breakdowns below.
Based on the same example above, if Bob simply increases his monthly repayment from $1,194.00 to $1,295.00, he’ll get the same results as changing to fortnightly repayments and paying the increased amount. So, Bob paying $1,295 per month is the same as him paying $597 per fortnight.
If Bob accepts the bank’s advice to ‘halve the monthly payment and pay fortnightly’, he pays $597.00 per fortnight. He is now effectively paying $1,295.00 per month - more than he was paying in the first place.
Here’s the maths on that:
$597 x 26 (fortnightly repayments) = $15,522* total repayments per year.
Or: $1,295.00 x 12 (monthly repayments) = $15,540* total repayments per year.(*small difference in these amounts is due to rounding).
Well done on making it this far through the article! To summarise: the savings in total interest paid over the term of the loan, and reducing how long it takes Bob to repay his mortgage, depends completely on how much he's prepared to pay per instalment and very little to do with the frequency of repayments.
In light of all of this, there is a very valid argument that if you are paid monthly, you’re better off with monthly loan repayments - especially if you tie in the repayment date with your payday. Otherwise, if Bob receives his pay on the 15th of each month he has to hold money in his account (earning next to nothing) to meet the next fortnightly repayment due. Bob is better off using his monthly salary payment on the day he receives it.
We at Mortgage First absolutely encourage our clients to get rid of debt as quickly as possible. If you can afford to pay more than the minimum repayments due, then absolutely go for it. You may be surprised how a relatively small increase in your loan repayments translates to significant interest savings and paying your loan back much faster. We're always here to discuss your specific circumstances and give examples of savings you can make.