If anyone ever tells you that paying your mortgage instalments fortnightly rather than monthly will provide significant cost savings, please consider this article before following their advice.
It is an urban myth that there are significant cost savings available by simply changing the frequency of the loan instalments. If the loan is geared to a 25-year term (and if the loan terms don't change) you will pay about the same amount in interest, over 25 years, whether your loan instalments are fortnightly or monthly. Let's take an example (using figures derived from the independent, Government website www.sorted.org.nz):
Loan instalments for finance of $500,000, on Principal & Interest terms over 25 years at 5.00%pa = approx. $2,923 per month. Over 25 years you would pay interest of approx. $376,885.
Loan instalments for finance of $500,000, on Principal & Interest terms over 25 years at 5.00%pa = approx. $1,348 per fortnight. Over 25 years you would pay interest of approx. $376,392.
The difference is approx. $493 over 25 years (a little under $20 per year), which could hardly be considered significant.
I think that the urban myth came about due to a misunderstanding, by some, around the benefits of halving the monthly loan instalment and paying that amount fortnightly (which results in a higher fortnightly instalment than it would have been if it had been calculated over the actual loan term).
Loan instalments for finance of $500,000, on Principal & Interest terms at 5.00%pa paid at approx. $1,461 per fortnight (i.e. half of the $2,923 per month detailed above) would enable borrowers to repay the finance over approx. 22 years. Over that term they would pay interest of approx. $316,226 (approx. $60,000 less than the above calculation).
So the real benefit lies not in the frequency of the payment, but in paying more than the minimum required amount (regardless of whether payments are made monthly or fortnightly). A number of banks have policies that enable regular instalments on both fixed and variable/floating rate loans to be increased. We will continue to encourage our clients to set up their loan instalments that best suits their circumstances and to reduce debt faster than they need to, if they are in a position to do so, as there are a range of benefits that they can enjoy as a result.
If you’re keen to know more about your options, please get in touch.