I have read somewhere that setting up a loan with half monthly repayments then paying fortnightly can save a lot of interest. Can you please explain? What should I instruct the bank to do when setting up the loan?
Martin Castilla, personal mortgage adviser with Smartline, sheds some light on your query.
"The answer to this question can make a huge difference in your loan term and therefore the interest you will pay on your home loan. This is why: lenders
work out principal and interest (P&I) repayments in different ways, which can be confusing. Some calculate weekly repayments as (A) annual repayments divided by 52 weeks of the year, or (B) annual repayments divided by 12 months of the year divided by four weeks in every month.
So, in dollar terms, on a $350,000loan over 30 years at 7.5%pa interest the repayments are $565pw for (A)
and $611pw for (B), even though both repayments occur on a weekly cycle, so you can see that paying by the second method you'd pay the loan off faster
because you are paying more off the outstanding loan balance each week.
The same effect occurs with fortnightly P&I repayments. You can make (C) annual repayments divided by 26 - known as 'true fortnightly' - or (D) annual repayments divided by 12 divided by two fortnights in every month - known as 'half monthly'.
So fortnightly repayments would be $1,129pfn for (C), and $1,223pfn for (D).
Again, one repayment being larger than the other, even though both repayments occur every second week, will help you pay your home loan faster because
you're paying off more principal each repayment (but the amount of interest in each repayment is the same).
Paying half your monthly repayment fortnightly can most definitely save you years and thousands of dollars worth of interest from your loan, but only if you
make the 'right' fortnightly repayment.
For instance, if you had a $300,000 loan at a 6%pa variable rate for 30 years, your monthly repayment would be $1,799, incurring $347,515 interest over
the life of the loan. If you make repayments via the
'half monthly' fortnightly method, your fortnightly repayments will be around $899 (compared to $830 for the 'true fortnightly' method), but you will only pay $274,115 in interest over the term of your loan, a saving of almost six years and $73,400 in total interest incurred.This is because you are making a larger fortnightly repayment, therefore reducing the interest-attracting principal quicker.
As you can see, it is very important to know which method your lender uses to calculate repayments so you don't underestimate your commitment, and, if
possible, set your automatic repayments to the larger amount regardless.
Your lender or personal mortgage adviser will be able to show you the loanterm and dollar savings benefit on a chart - and it's often a dramatic saving!"