A common question we get from borrowers is do you pay less interest if you pay your loan fortnightly? A long-held belief is that if you are paying fortnightly then you will pay your loan off faster – but this isn’t always the case. Read on for more.
Will I pay my loan off faster if I pay fortnightly?
Theoretically yes, and the reason for this is because the lender calculates your interest repayments daily. So, if you’re paying fortnightly then you’re reducing your principal loan amount fortnightly rather than monthly. This means for the second fortnight of the month, the interest payments will be calculated on a lower balance, therefore reducing your interest.
As you can see the savings aren’t very substantial initially, just a few dollars a month, but these compound over time and you’ll see bigger savings the longer the loan run as you’ll commence paying your principal off earlier.
If I pay fortnightly am I making extra repayments per year?
Another common held belief is that by paying fortnightly you’re making 26 repayments each year rather than 12 if you pay monthly, which means you pay your loan off faster. This is possible, however the lender usually calculates what you need to pay across the loan term and then determines what your regular loan repayments will be to ensure you pay the loan off within the given term.
If you decide to split your monthly repayments in half and pay fortnightly, then you’re actually making an extra months’ repayment each year as 52 weeks = 26 x 2 = 13 x 4. It works out to be 13 monthly repayments rather than 12 across the year.
However, some banks don’t calculate fortnightly in this way – they take your monthly repayment, multiple is by 12 and then divide it by 26. So, you wouldn’t actually be paying any extra by doing is this way.
Here are two examples:
26 repayments (divide monthly in half)
$5,000 monthly repayment = $60,000 per annum
$2,500 fortnightly repayment = $65,000 per annum
26 repayments (divide annual amount into fortnights)
$5,000 monthly repayment = $60,000 per annum
$2,307.69 fortnightly repayments – $60,000 per annum
Aside from paying an extra $5,000 on your loan each year by paying your monthly amount halved every fortnight, you’d also be saving on interest too.
Even if the bank calculates the rate to be $2,307.69 you can choose to round up to $2,500 to achieve the same outcome (unless you have a fixed rate loan, in which case you often aren’t able to make extra repayments during the fixed term).
Check out our online loan repayment calculator to see how much interest you could save by making extra repayments: https://entourage.com.au/resources/loan-calculators/loan-repayment-calculator/
You don’t have to actually make extra repayments to achieve the same interest savings
Here’s the secret sauce though. You don’t actually have to make the extra repayments to be able to save on your interest. You could put the extra $5,000 per year into your offset account to achieve the same outcome.
Your offset account acts to reduce the principal amount the bank is calculating your interest on each day. This means by putting your savings, any lump sums you receive or just making extra contributions, you will pay less interest but can access those funds at any time should you need them.
Do you pay less interest if you pay your loan fortnightly?
You’re not alone, there are a lot of different factors which impact the outcomes we have highlighted here including things like annual fees charged by the banks, changes to interest rates, whether you redraw on the loan and much more.
If you’re ready to chat with a broker about your lending options get in touch with us today.