Bi-Weekly mortgage payments, what’s that?

How to pay that mortgage off faster.

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Your mortgage has been approved, and now your lender presents you with yet another choice: how often do you want to make your mortgage payments? The mortgage advisor is throwing around terms like monthly, semi-monthly, bi-weekly, and accelerated bi-weekly. Monthly repayment seems fairly clear to you, but what do these other options mean? What’s the difference between bi-weekly and accelerated bi-weekly? And does it even make a difference which option you choose?

It does. Your choice of payment frequency can have a big effect on how fast you pay off your mortgage and thus how much interest you pay. To see how, let’s work through an example. We’ll start by assuming that you’re borrowing $150,000 to buy your home, the interest rate is fixed at 4%, and you’ve decided to pay your mortgage off over 25 years (the amortization period).

Monthly Payments

If you opt for monthly payments, then on the same day of each month the bank will take a payment of $789.03 towards your mortgage. Each year you will pay $789.03 per month x 12 months = $9,468. Over the 25-year amortization period, you will pay a total of $236,751 to the bank. So in addition to paying back the original $150,000 you borrowed, you will pay $86,751 in interest.

Semi-Monthly Payments

Instead of paying $789.03 once a month, you’ll pay half that amount ($394.52) twice per month, on the first and the fifteenth. In other words, you’ll make 24 “half-size” payments per year rather than 12 “full-size” ones. Thus, the amount you pay per month won’t change, but the timing of your payments will. Will this make any difference to the total interest that you’ll pay? Yes, but the amount you save is very small because the annual total is the same as before ($9,468). The only difference is that by paying semi-monthly rather than monthly, you move your payments ahead slightly. What do you save over 25 years? It’s $222 in this example. That’s not much, so how could you save more?

Accelerated Bi-Weekly Payments

In this case, your regular payment amount is the same as in the semi-monthly case: $394.52. But rather than paying this amount twice per month, you pay it every two weeks. So over one year you end up making 26 payments rather than 24 payments. This is equivalent to making one extra monthly payment per year, for a total of $394.52 bi-weekly x 26 bi-weekly payments = $10,257 annually. Because you pay that extra amount each year, you pay your mortgage off significantly faster and save a huge amount of interest. In this example, your total interest payments would be reduced by $12,760 to $73,991 and your amortization period would go down from 25 years to less than 22 years. Now that’s more like it!

However, note that if you opt for bi-weekly payments rather than “accelerated” bi-weekly payments, then the situation is not much different to semi-monthly payments. The total annual payment is the same as in the monthly and semi-monthly case ($9,468) but spread over 26 payments rather than 12 (monthly) or 24 (semi-monthly).  So your bi-weekly payment would be $9,468 / 26 = $364.17 rather than $394.52 (accelerated bi-weekly case), and your interest savings would be similar to the semi-monthly case, i.e., very small.

The word “accelerated” implies that your total annual payment increases compared to the monthly case. But the advantage of accelerating your payments is that you save a lot of interest. Increasing the frequency of your payments without changing the annual total (e.g., opting for bi-weekly rather than accelerated bi-weekly payments) will save you a small amount of interest, but it’s nothing to write home about. Therefore, if you can afford that little extra each year, it makes sense to choose an accelerated bi-weekly schedule.