Liam Croke: Save on your mortgage via an 'extra payment'

Liam Croke

Reporter:

Liam Croke

Liam Croke: Save on your mortgage via an 'extra payment'

Save on your mortgage by paying it every fortnight instead of every month

There are a number of different ways you can accelerate the repayment of your mortgage. You can make lump sum lodgements. You can overpay each month. You can ask your lender to reduce the term remaining.

But, there is another method, which is quite simple to implement, yet is highly effective and its impact can save thousands in interest repayments. And it’s how frequently you repay your mortgage.

Depending on where you buy, the average price of a property according to Daft.ie in Limerick is about €180,000. If you borrowed 90% of this amount over a 30-year term, and made repayments once a month, the amount of interest you would repay, if the mortgage ran to term, is €116,428.

If, however, you repaid the mortgage every two weeks, the amount of interest you would pay is €97,492. So, in this instance, you would save €18,936 in interest repayments, and your mortgage is cleared five years earlier.

How It Works

Since there are 52 weeks in the year, if you make a 50% repayment on your mortgage every two weeks over the course of a year, you will make 26 half repayments, and that’s the same as 13 full repayments, or one more payment than there are months in the year.

Example

If your mortgage repayment is €1,000 and you pay every month, you will pay €12,000 over the course of a year i.e. €1,000 x 12 months.

If you split your mortgage down the middle and pay €500 every two weeks, you end up paying €13,000 i.e. €500 x 26.

And by applying that extra payment amount which is directed to your capital only, you reduce the amount of interest you pay. Every month, your mortgage payment goes towards paying the interest portion of your loan and towards the capital outstanding. In the beginning of your mortgage, when your balance is at its highest, most of your mortgage payment is going towards interest payments, with very little going towards reducing your principal.

For example, the mortgage repayment on €162,000 (€180,000 x90%) at 4% over 30 years is €773. Of this amount, on average €535 is going towards interest payments in the first year and €238 towards the capital. It will take about 12 years before you end up paying more in capital than you will in interest payments.

The key therefore, if you want to make maximum impact on your mortgage, is to start this method of repayment early, because any interest payments already made are gone and can’t be recovered and saved. That’s not to say, just because your mortgage isn’t a new one, that you shouldn’t switch to paying every two weeks. You should consider it and review the impact it would have on your mortgage, and if its good enough for you, then you should switch.

But paying twice a month and every two weeks are not the same! There can be some confusion surrounding this issue and there is quite a difference between paying twice a month and every two weeks – they are not the same. Paying your mortgage twice a month will save you very little. By doing this, you are making two payments each month instead of one, adding up to the equivalent of 12 full annual payments. By making repayments this way, in the example I have already referred to, you would only reduce the term by on month and save c. €17 in interest payments.

However, if you make a payment every two weeks, you will save €19,000 because you are making 13 annual repayments rather than 12. The savings therefore, come from that extra payment you make each year toward the principal, not the timing of paying every two weeks. Financial institutions do not promote this method of repayment as it reduces the amount of interest they will receive from you.

Just because it doesn’t suit them doesn’t mean it can’t be done. If they can’t facilitate you, you just set up a standing order from your account every two weeks directly into your mortgage account, it’s that simple. You will see the balance reducing at a faster pace than it had been. However, don’t start making biweekly payments without notifying your lender and advising them of your intention. You can’t just decide to alter and change the terms of your loan agreement without telling them first, so you need to put in writing what you are going to do, and why you are doing it.

If you get paid every two weeks then making payments every two weeks is easier to implement and budget for, and it won’t really feel like you are making an extra payment each year. The advantage I see in implementing this is not just the interest saving, but also those months you are not paying your mortgage. In the example I have been using, by repaying your mortgage five years earlier it totals €46,380 (€773 x 60) which can be redirected to other areas of your finances if you wanted to.

If paying every two weeks doesn’t suit, and you didn’t want to amend your direct debit and set up a standing order etc. there is an alternative option, which has more or less the same impact, and that is by making one extra payment each year.

Choose a month in the year, where you decide to make two repayments instead of one (December or January is a good time to do this when you might be in receipt of a tax refund or an annual bonus) and make this a habit and something you do at the same time every year, because as you can see it can bring big savings to you over the life of your mortgage.

Liam Croke is MD of Harmonics Financial Ltd,

based in Plassey. He can be contacted at liam@harmonics.ie or www.harmonics.ie