Fortnightly …. To Be or Not to Be ….
I can tell from the questions I am being asked that rates are starting to have an effect and people are being not only more careful with their money but also trying to create additional value.
Tell me who “hasn’t” heard that paying a loan fortnightly shortens the loan term?
As a mortgage broker with an honors degree in theoretical physics – I am possibly one of the MOST qualified brokers to have a reliable opinion on this.
Let’s do this WITH and WITHOUT an offset account
WITHOUT
- Interest is calculated daily (and is invisibly added to your loan balance – daily)
- You pay the loan monthly – so the bank has compounded the daily interest for 30(ish) days before you reduce it.
- You pay the loan fortnightly – so the bank has compounded the daily interest for 14 days before you reduce it.
- The credit contract is calculated over 30 years assuming the former – if you pay what they say – it is paid off in 30 years.
- If you pay the loan off fortnightly – you do get a miniscule difference (because of the micro compounding) and your loan is paid off in 29 years and 9 months.
- Haha… trust me… I used to be a maths teacher!!
WITH
- If you pay your salary into an offset account – fortnightly – or “anythingly” – then EVERY $ is reducing interest DAILY.
- Now, paying fortnightly OR paying monthly – will pay the loan off in EXACTLY the same time.
- There is not even a bee’s whisker of difference.
- You will pay the loan off sooner – that is the interest offset effect. How much sooner will depend entirely on how much money you hold in your offset account.
- If you would like an example to suit your situation – Ask Alan – I have the skills to answer your question.
This is not possible I hear people say almost all the time – the banks tell us fortnightly is faster.
Well – two things … haha … I taught many people who went into banks – and many people who go into banks aren’t great at maths (unless they are in research at Macquarie!!)
Let me dispel this fallacy by example.
Let’s assume that paying more frequently pays a loan off sooner.
So … Monthly 30 years
Fortnightly? – that’s much quicker … right?
Ok then – let’s do weekly … better still!!
Let’s not stop there …. DAILY !!! – we’ll have this thing paid off in no time.
Hey… if we pay this loan off “Microsecondly” – it will be paid off by lunchtime.
This is proof by counter example – and when a conclusion is ridiculous there is an error of logic somewhere – and in this case it is at step 1 – fortnightly.
So how did this fallacy start
- In days gone by – if you asked for fortnightly – the bank halved the monthly payment, and you paid it 26 times.
- That is two more payments per annum than required.
- Your loan is paid off in 24 years (yes the math teacher again).
Your loan is paid off more quickly because you have paid MORE…. Not because you paid more often.
Aaahaa … light bulb moment 💡.
If you have an offset account and you want to pay the loan off more quickly – put EVERYTHING you can into that account as often as you can.
Then pay the loan back by any frequency that suits you, or is provided by the bank – it makes ZERO difference.
Fallacy number two – having an offset account pays your loan off quicker…. Wrong.
(Too good to be true again).
HAVING MONEY in an offset account pays your loan off sooner.
As always – if you have questions or would like advice tailored to your own circumstances, Ask Alan, it’s what I’m here for..
Ask Alan – Mortgage Broking with a difference.