I’ve yet to meet someone who likes having a mortgage. Once the honeymoon phase of home ownership fades the focus quickly turns to how best to pay off the mortgage.
The key to getting rid of your mortgage may come down to the type of mortgage payment you select. Before I go any further, it’s important to understand a couple of things about mortgages. The interest on a mortgage is not calculated in advance and the compounding period for mortgages are semi-annually. What does that mean for you? It means frequency along with additional payments are critical to cutting years off your mortgage and saving on interest cost.
What types of mortgage payment options are available?
There are 6 different types of mortgage payments available. They are monthly, semi-monthly, bi-weekly, weekly, accelerated bi-weekly, and accelerated weekly. When deciding on a payment option most people pick the one that matches their pay schedule. If you’re paid monthly, you’re likely to lean towards a monthly mortgage payment. Picking a payment option that matches with your pay schedule might be convenient but could result in you having a mortgage longer and paying more in interest costs.
What’s the best mortgage payment option?
The best mortgage payment is one that enables you to make more frequent payments within a year while also making extra payments within the year. As such, the best mortgage payment option would be an accelerated weekly payment as you make payments every week. While it’s the best mortgage payment options to taking years off your mortgage, most of us do not get paid weekly. Therefore, the most common payment option selected by most people is biweekly or monthly still as it more convenient with their pay schedule.
What’s the difference between a bi-weekly and an accelerated bi-weekly payment?
Most people select a bi-weekly payment option when they are seeking the effects of an accelerated bi-weekly payment option. Bi-weekly payment takes the equivalent yearly monthly mortgage payments and divides that figure by 26 to determine your bi-weekly payment amount. The actual dollar amount you pay with a monthly or biweekly payment will the same, however, you will reduce your amortization slightly and save some interest due to the frequency of bi-weekly payment.
Accelerated bi-weekly payment calculation is slightly different. To calculate your accelerated bi-weekly payment you take your monthly equivalent mortgage payment and divide that amount by two and then make 26 equal payments throughout the year. As a result, you end up paying more per year with an accelerated bi-weekly payment option compared to bi-weekly payments.
A case study to illustrate the effects of mortgage payment options
Let’s assume you get $100, 000 mortgage and put down 5% on a 5 year fixed term mortgage. The interest rate on the mortgage is 3% and there is mortgage insurance since it’s a high ratio mortgage. The chart below shows all the different payment options available and the impact they would have on the amortization.
|Payment Frequency||Monthly||Semi-Monthly||Bi-weekly||Weekly||Accelerated bi-weekly||Accelerated weekly|
|Amortization||25 years||25 years||24 years & 11 months||24 years & 11 months||22 years & 2months||22 years & 2 months|
|Term Interest Cost||$13, 650.19||$13, 631.46||$13, 579.70||$13, 571.00||$13, 399.43||$13, 390.02|
|Amortization interest cost||$41, 310.21||$41, 180.14||$40, 940.82||$40, 878.81||$36, 040.74||$35, 984.02|
After reviewing the chart, you can see a monthly payment option is the least effective payment option for reducing your amortization and saving on interest cost. The best option is an accelerated weekly payment option which cuts a 25-years mortgage down to 22 years and 2 months. A bi-weekly payment will reduce your mortgage amortization to 24 years and 11 months, which 1 month less than a monthly payment option. If you selected an accelerated bi-weekly payment frequency will take almost 3 years off the mortgage amortization.
The difference between a bi-weekly and accelerated bi-weekly payment is $17.92 biweekly. Yet, the payment made with an accelerated biweekly payment at the end of the year is $465.90 more than a bi-weekly payment. That works out to an additional $2, 329.50 by the end of the 5-year term simply by selecting an accelerated bi-weekly payment option.
The takeaway is clear. Accelerated payments are the way to go. Since most of us get paid bi-weekly you should be select an accelerated bi-weekly payment frequency for your mortgage. Avoid selecting a monthly or a bi-weekly payment option for your mortgage due to the long term costs it can have.