Are fortnightly repayments a swing or a miss?

You've probably heard that repaying fortnightly or weekly can help you pay off your mortgage years earlier and save tens of thousands in interest.

However research from RateCity.com.au has found that the way lenders calculate these payments could catch them off guard.

If you're thinking about switching to fortnightly payments to save money, remember that the amount you save depends on your lender's calculations, so it's worth considering your options carefully.

The two ways to calculate fortnightly repayments

There are two ways banks calculate a customer’s repayments if they are switching from monthly to fortnightly amounts:

1. dividing the customer’s current monthly repayments by 2; or
2. multiplying the customer’s current monthly repayments by 12, then dividing this figure by the number of fortnights in a year, 26.

The ‘divide by 2’ method

Halving the monthly repayments and paying this fortnightly will see customers make an extra two fortnightly payments a year.

That’s because the repayments are calculated based on there being 24 fortnights in the year (2 x 12 = 24) but the customer ends up paying this amount 26 times a year, not 24.

The ‘multiply by 12 then divide by 26’ method

This is the more mathematically accurate way to calculate fortnightly repayments, however, it doesn’t result in customers paying significantly more each year.

That said, because home loan interest is calculated daily, any payments made earlier than usual will help reduce that month’s interest bill.

How much of a difference does it make?

If you want to pay off your mortgage faster, dividing your monthly payment in half and paying that amount every two weeks is a smart choice, as long as you can afford it.

According to RateCity.com.au's analysis, if you have a \$500,000 debt with 25 years left on your loan and switch to fortnightly payments using the 'multiply by 12, divide by 26' method with your bank, you could save approximately \$8,142 and pay off your loan three months earlier.

But if your bank uses the 'divide by 2' method, you could potentially save a whopping \$97,584 and pay off your loan four years and three months ahead of schedule.

This calculation is based on an owner-occupier making principal and interest payments at an average interest rate of 6.23% with 25 years remaining on their loan.

Impact of paying fortnightly

Based on an owner-occupier with \$500,000 debt, 25 years remaining

 Interest – remainder of loan Difference to monthly Time saved Monthly repayments \$488,748 Multiply by 12, divide by 26 method \$480,605 -\$8,143 3 months Divide by 2' method \$391,165 -\$97,583 4 years, 3 months

What does your bank do?

RateCity.com.au research shows that only a handful of Australia’s largest banks use the ‘divide by 2’ method, with the remaining using the ‘multiply by 12, divide by 26’ method.

 Bank Method to calculate fortnightly repayments CBA Multiply by 12, divide by 26 Westpac + St. George + Bank of Melbourne + BankSA Divide by 2 NAB Multiply by 12, divide by 26 ANZ Multiply by 12, divide by 26 ING Multiply by 12, divide by 26 Bendigo & Adelaide Multiply by 12, divide by 26 Bank of Queensland Divide by 2 Suncorp Multiply by 12, divide by 26 HSBC Divide by 2

Don’t let your bank dictate your life

Even if you're stuck with a lender that calculates repayments every 26 fortnights, you can cut years off your mortgage and potentially save a lot of money by paying more than the minimum.

For instance, if a borrower has a \$500,000 debt with 25 years left and increases their payments by \$126 every fortnight, they could still finish paying off their loan 4 years and 3 months ahead, assuming the lender calculates fortnightly payments correctly (by multiplying by 12 and dividing by 26).

However, it's important to note that when interest rates change, it's usually the borrower's responsibility to adjust their payments accordingly.

Impact of additional repayments

Based on an owner-occupier with \$500,00 debt, 25 years remaining

 Total interest - remainder of loan Difference to monthly Time saved (months) Time saved (years) Monthly repayments \$488,748 Fortnightly repayments + \$126 extra \$391,515 -\$97,233 51 4 years, 3 months

RateCity.com.au research director, Sally Tindall, said:

“While many families are struggling to stay afloat, those with even a sliver of wiggle room in their budget should consider chipping in extra to their mortgage.

However, households switching to fortnightly repayments could find it’s a swing and a miss if their bank doesn’t play ball.

Some borrowers like to trick themselves into paying extra by switching to fortnightly repayments, but exactly how much you’ll pocket can come down to how your bank calculates the maths.

While dividing a customer’s monthly repayments by two to calculate the fortnightly amount might not stack up mathematically, it has the potential to save some borrowers thousands, if not hundreds of thousands of dollars over the life of a mortgage and shave years off their home loan.

That’s because the bank is basing the calculation on 24 fortnights a year, not 26, which means customers pay the equivalent of two extra fortnights a year, in addition to the benefits that come from paying more frequently to help reduce your daily interest charges.

Westpac, Bank of Queensland and other lenders have purposely kept the formula this way to help their customers get ahead – something these banks should be congratulated for.

Customers with a bank who calculates fortnightly repayment by multiplying the monthly amount by 12 and then dividing it by 26, won’t be paying two extra fortnights a year."

She further commented:

"However, these customers will still see small savings over the longer term by paying more frequently.

That’s because home loan interest is calculated daily, and any payments made earlier than usual can help reduce that month’s interest bill.

If you’re looking to get ahead by switching to fortnightly repayments, check which way your bank calculates it.

If you find you’re not going to pay extra, ask the bank to increase your minimum repayments so you do.

Just be aware, that if you’re controlling your extra repayments, you may need to recalibrate this amount if and when your rate changes.

Paying extra into your mortgage isn’t likely at the top of many families’ priority lists right now, but the more you can contribute, the bigger the buffer you’ll have to fall back on if you hit a bump in the road.

Extra repayments also help reduce your interest bill which can be critically important in a high-rate environment."

About Chris Dang Chris Dang is an accountant by training and has worked in the Financial Planning industry for many years. Chris brings together property, accounting, and financial planning experience to help clients of Metropole Wealth Advisory create a holistic plan for their wealth.