by J L Petriesan

Created on: December 03, 2008   Last Updated: October 02, 2011

The question "Do biweekly payments save you money?" needs a little definition before it can be answered. Are we talking over the life of the contract or any given interim period? Does the contract provide for the payment of interest?

The concept behind this is that payments are typically made monthly, twelve times a year. Many of us get paid every-other Friday, or 26 times a year. So, if we divide the payment required monthly in half and pay that amount out of each paycheck, we will be making the equivalent of thirteen monthly payments each year.

If a house payment is $1,000 a month and we pay monthly, we will pay $12,000 per year; if we pay bi-weekly, we will pay $13,000 during the same year. Is this a good thing? If there is no interest on the debt, the answer is a resounding no! However, if there is interest, say on a house payment, where this question seems to come up the most, the answer is yes, paying bi-weekly will save you money in the long run, but you will pay more each year.

How does paying more frequently save you money? Because interest is computed based on the days a debt is outstanding. If you pay more frequently, the interest accrued since the last payment is less, which means more of the payment goes to reduce the debt, which results in less interest, and so on.

Let's look at an example. If you owe $100,000 at 10% interest and the payment is $1,000 per month, the interest after 30 days will be $833 (100,000 X10% X30 days/360 days). After making the payment, you will owe $99,933 ($100,000 less $1,000 payment plus $833 interest). After a year of making 12 payments totaling $12,000, you will still owe $97,905. If, on the other hand, you make the payments religiously every 14 days, the interest on the first payment will be $388 (100,000 X10% X14 days/360 days) and you will owe $99,888 ($100,000 less $500 payment plus $388 interest).

If you make all the payments according to schedule, on the monthly plan you will pay a total of $216,000 to retire that $100,000 debt and it will take 18 years. On the bi-weekly plan, that extra $1,000 per year will mean you will make payments totaling only $194,000 in about 15 years, a savings of $22,000.

Most lenders will let you do this, but you need to talk to them about it first. If they will not let you do it, you can accomplish much the same thing by adding a little to each payment, which virtually all lenders will allow, just be sure you note it as extra principal. The amount to add to the monthly payment of $1,000 to achieve the same savings as paying, or $500, every two weeks is about $75 a month, or $900 per year.

Whatever you do, the key is to pay the debt off as soon as possible. Sure, you can deduct mortgage interest off your taxes, but that is a red herring. If you are in the highest tax bracket, there is no way you could even save half the amount in taxes as you paid in interest. Get out of debt and invest the money.

Now, there are those who say if the interest rate is 6% and you can earn more than that by investing the extra payments, the $1,000 per year, then you should not pay off the low interest rate loan. From the standpoint of pure theory, I agree. But, in practice, investing seldom happens. It is too easy to let the excess slip away to Starbucks or Cinemark or whatever. In the end, the choice is yours.

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