It has become accepted wisdom among financial advisers and commentators to recommend fortnightly mortgage payments as a way to save interest. But mortgage broker Craig Seton of Mortgage Link says that lenders do not automatically set them up to save money for customers. He believes that many borrowers may not realise this.
“When paying fortnightly the repayments must be based on half the monthly equivalent. If paying weekly the payments must be calculated at a quarter of the monthly equivalent,” Seton explains.
“Most lenders do not calculate repayments for weekly or fortnightly options this way,” says Seton, who has worked in the banking industry. “Instead the payments are simply calculated to equate to the same annual repayments that paying monthly achieves.”
A mortgage of $250,000 at 8% over 30 years will cost $1834 per month and interest over the term of the loan will be $410,000. If however you pay $917 per fortnight (half of the monthly equivalent) you will repay your mortgage off 7 years earlier and save $113,000 in interest.
However if the lender calculates the repayments fortnightly based on paying the same amount per annum, as if you paid monthly, this would result in repayments of $846 per fortnight. Despite paying fortnightly you still pay your loan off over 30 years and only save $284.
A Consumers’ Institute guide to mortgages explains: “Broadly speaking a month is two fortnights. But there aren’t 24 fortnights a year; there are 26. Paying half your monthly repayment every fortnight means in effect that you will make an extra month’s repayment each year. “
Consumer calculates that the saving on a $150,000 loan over 20 years at 6.70% will be $21,000 if paid in this way.
Good Returns approached several lenders to ask for their methods of calculation. Two responded in detail, Westpac and ASB. Westpac pointed us to the explanation of the fortnightly system in its website guide to homeloans. “By paying half of your monthly payment on a fortnightly basis you end up making two extra payments a year. So, on a $100,000 home loan, you can cut nearly five years off your loan saving about $28,000 or 23% in interest.”
A spokesman agreed that this was one of two methods for calculating fortnightly payments but that both were explained to customers.
A spokesman for ASB claimed that it was misleading to state that there were two methods for calculating fortnightly payments because borrowers usually aligned their payments with salary frequency.
“ASB gives clients the option to pay either monthly or fortnightly, depending on the circumstances, and makes clients aware that any increase in their repayments reduces the term of their loan and therefore the overall interest paid.”
Good Returns would like to hear from borrowers about their experiences in setting up fortnightly payments. Do you know whether you have the money-saving system and did the bank explain the options? Email: feedback@goodreturns.co.nz
