An article (April 22, 2004) appearing in a Canadian National newspaper, “When you borrow money to buy, do not overpay” does not live up to its heading as far as the mortgage mathematics is concerned. First of all the author fails to understand most Canadian Banks today use a 365 day year in calculating weekly payment schedules. Secondly the author does not appear to understand the importance of the three types of weekly payments.
The newspaper example is a $240,000 mortgage amortized for 25 years at 4.6% using semi-annual compounding and making weekly payments. His solution (to not overpay) is to lower the amortization period to 20 years and pay the larger weekly payment. Great idea, but the logic is based upon the minimum weekly payment. The net effect is that the ensuing weekly payment (based upon 20 years amortization) ends up being greater than the correct accelerated weekly payment (which is good) so this is an example of two wrongs making a right.
What if you cannot qualify or afford to shorten the amortization period to 20 years from 25 years. Unless you are aware of the three popular types of weekly payments (there are an infinite number of weekly payments) you will not be aware of one of your savings options, that costs you nothing!
The oversite, a 360 day year vs a 365 day year, is not critical in his flawed analysis, because the minimum weekly payment quoted understates the savings by an amount of $510 ($1,096.69 - $586.53 ) if the borrower elected to remain with the 25 year schedule while making the minimum weekly payments. What is critically wrong is the author uses the minimum weekly payments in his analysis. He should have informed the readers about the differences in the three weekly payments that are usually offered by the Banks.
Before describing this critical flaw regarding an apparent misunderstanding
of the weekly payment plans I will reiterate the only rule to remember
to save interest on a mortgage. PAY BACK THE LOAN AS QUICKLY AS POSSIBLE!
Prior to the introduction of weekly payment mortgages in Canada (1984)
the only way to pay back a mortgage as quickly as possible was to increase
the monthly payment, therefore automatically reducing the amortization
period. For a given principal and annual interest rate, when the payment
is increased the amortization period must decrease according to the laws
of algebra. If you decrease the amortization period for a given principal
and interest rate the payment must increase according to the laws of algebra.
The result is exactly the same. The interest clock is started the moment
you borrow money. The sooner you make a payment, the less interest you
This is the way mortgage should have been handled!!!
If you pay $1341.71 per month it will take 25 years to pay off the mortgage. If you pay $309.63 per week it will take 24.87 years to pay off the mortgage, BUT you will save $2,032.74 cents for doing nothing, which is why I call it free money! The non accelerated weekly and the monthly is the same amount of money paid back to the Bank at the end of the year. If you pay $335.43 per week it will take 21.59 years to pay off the mortgage and you will save $25,990.19.
MINIMUM WEEKLY PAYMENTS:
NON ACCELERATED WEEKLY PAYMENTS:
The weekly payment is not carved in stone and if you told your Banker that you wanted to pay $351.57 per week the correct interest cost would be approximately $125,001, which is a $1000 less than the misinformed writer arrives at. If you want to pay $360 or $370 or $400 per week you can if your budget allows it.
If you are not aware of these three weekly payments you would miss the free money!
Some may say that $2,032.74 is not much however if the interest rate
was 12% (and they will be there in a few years) the free money becomes
$25,246.53 which is also enough for a new car. And in this example if
rates ever go to 20% (as they did in early 1980s) the free money becomes
$169,749 which is almost unbelievable.
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