Many of us purchase our homes, our cars, or our education through the process of financing. We take out a 30-year fixed rate mortgage, 5-year car loan, etc. so that we will be able to own and use an asset without having to pay for everything upfront in cash. So, we borrow and pay down the loan with both principal and interest for a number of years.

Interest rates and payments, especially in the low-interest rate environments, often times do not seem like meaningful numbers because we tend to compartmentalize how we view the payments.

For example, let’s say you have a 5-year loan of $10,000 on your car and an annual interest rate of 2%. You look at what the monthly car payment will be and notice that you will be paying (on average over the course of the loan) about $9 per month in interest. Looking at that as a single line item makes it seem minimal. It’s a manageable cost that doesn’t upset me one bit.

But, when you look at it all together, collectively, to determine how much interest you will pay over the life of the loan, that number will creep up pretty quickly. In the previous car loan example, your interest that you paid over the course of the 5-year loan amounted to just over $500. That is 5% of the loan itself.

Interest Creeps Up Pretty Quickly

Debt doesn’t have to be viewed negatively, though. Financing certain things, like purchasing a home, provides you with the opportunity to own a home that most would not be able to afford in cash. Your using leverage to invest in an asset, ideally an appreciable asset and one that has the potential to grow over time.

Instead of depleting all of your cash to purchase something, you can make monthly principal and interest payments over the term of the loan and use your cash on your lifestyle, for security or other income-producing activities instead.

Especially in a low-interest rate environment, one could make a pretty strong argument around using debt to leverage certain financial opportunities with the understanding that your money could earn more if invested elsewhere, as opposed to paying down debt.

In other words, am I better off accelerating the payoff of my 3% fixed 30-year mortgage or am I better off using that additional money to invest in the stock market or other business venture that may have the opportunity to yield a greater return to me over time? That, my friend, is using debt to your advantage.

But if there were a way to leverage debt to my advantage while also reducing the total interest paid over the life of the loan, you can bet I’d be paying close attention. The not-so-secret, secret…

Bi-Weekly Payments – How Do They Work

Paying down your long-term debt in bi-weekly payments as opposed to monthly payments could shave years off your loan and reduce your overall interest payments by a significant amount. (For purposes of the rest of the post, I will be using mortgage payments as an example, but the concept of biweekly payments and the benefit you receive could apply to all forms of debt that allow it).

Depending on the mortgage, you agree to pay a stated monthly payment that consists of principal and interest (unless it’s an interest only loan). This would consist of 12 monthly payments throughout the year.

However, with bi-weekly payments, you pay once every two weeks. There are 52 weeks in a year, so you would be making 26 payments. By paying bi-weekly, you have now set yourself up to pay an additional month’s payment within the same calendar year. (Note: Bi-weekly does not mean twice per month. That would only amount to 24 payments throughout the year).

For example:

• If your monthly mortgage payment was $2,000, you could expect to have cash outflows of $24,000 for mortgage payments throughout the year.
• If you opted to make bi-weekly payments, you would take your monthly mortgage payment, reduce it by half and pay that amount every two weeks. In this example, you would pay $1,000 every two weeks. This would amount to $26,000 for mortgage payments throughout the year.
  
  

The logic behind paying bi-weekly is that increasing the frequency of your payments reduces the interest build-up on a monthly basis and over the course of a 30- or 15-year mortgage. This could mean a significant reduction in your payoff date and the interest you pay over the life of the loan.

Top 3 Reasons to Consider Bi-Weekly Payments

• Reducing the time in which it takes for you to pay off the loan
  • By paying your mortgage bi-weekly, you will be chipping away at your principal balance faster than had you paid monthly mortgage payments.
    
    
• Reducing the amount of interest you pay over the life of the loan
  • By chipping away at your principal balance, you are also in turn, reducing your total interest paid over the course of the loan. This can be a VERY meaningful number depending on your loan term and interest rate.
    
    
• You will build equity in your home at a faster rate
  • And again, by chipping away at principal, you are increasing your equity/ownership in your home at a quicker pace. This will allow you more flexibility with HELOC’s for home improvement projects and will also put more money in your pocket come the time when you sell your home.
    
    

Bi-weekly payments is also a forced savings and budgeting tool. Any time that you can automate a transfer to a retirement investment account or automate payments to pay down debt – you will benefit by not having to actively engage in the transfer or give yourself the opportunity to change your mind.

Automation in personal finance is one of the most efficient ways to create the habits you need to build wealth.

How Bi-Weekly Payments Impact the Numbers

Depending on your mortgage, typically in the beginning years of a mortgage, your payments consist of more interest than principal pay off due to the fact that your loan amount is the highest it will ever be.

The interest you pay monthly is based on the previous month’s principal loan balance. So, the more you can drive down the principal of your loan, the less interest you will have to pay. Bi-weekly payments accomplish this without a huge payoff upfront!

Type of Loan: 30 Year Fixed Rate Mortgage at 3% in the amount of $500,000 starting on 1/1/2022

• Monthly Payments:
  • Monthly payment: $2,108 ($25,296, annually)
  • Date Loan Paid Off: 1/1/2052
  • Total Interest Paid Over Life of Loan: ~ $258,887
    

• Bi-Weekly Payments:
  • Bi-Weekly Payments: $1,054 ($27,404, annually)
  • Date Loan Paid Off: 06/01/2048
  • Total Interest Paid Over Life of Loan: ~ $224,492
    
    

By opting to pay bi-weekly mortgage payments as opposed to monthly, you saved approximately $34K of interest (that’s a 13% reduction) and you were able to pay off the loan 3 1/2 years early.

Things to Keep in Mind

Remember to check with your mortgage provider to see whether or not they offer the bi-weekly payment option. Two things to confirm would be whether they will charge any fees to set up the bi-weekly payments or if there are any prepayment fees on your mortgage agreement.

The power that paying bi-weekly payments can have on your loan will depend on a variety of factors, including your interest rate, term of loan, type of loan and whether or not fees will be charged as a result of the change.

But like anything as it relates to personal finance, it will definitely be worth looking into if you can manage the additional cash flow going out on an annual basis through the additional mortgage payment!

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