It has been said that if we do not study history, it will repeat itself. Here is an example. Weekly payment mortgages are still misunderstood after being available in Canada for 20 years. It seems like mortgage specialists and mortgage articles are popping up like crocuses in early spring. A recent mortgage article in a national newspaper, National Post, May 24th 2003 caught my attention because it was misleading. The article was intended to show borrowers how to save interest costs on their mortgage. The best technique in saving interest costs was not even mentioned; that is WEEKLY PAYMENTS. Readers are left with the wrong impression that interest calculations are complicated and purposely biased in favour of the lender.
The first bit of junk food mathematics incorporates both semantics and mathematics. The author states, “mortgages are structured so that most interest costs are loaded up front.” That statement is plain and simply wrong!!! The large interest costs in the early years of a mortgage are due to interest calculations on a large outstanding balance. There are no loaded up front costs in mortgage interest calculations. When money is borrowed, interest costs are calculated on the outstanding balance at the end of each payment period. This is high school mathematics. An amortization schedule would easily show that to be fact.
The second point was the omission of the weekly payment mortgage. To compound the confusion the writer’s solution was based upon an unrealistic premise. He suggested, doubling up on the monthly payments. Sure, just cut out the extra Blockbuster movie rentals each month and increase your monthly mortgage payments from $1000 to $2000 per month. Duh! Most people cannot afford the luxury of doubling their mortgage payments. The author should have been telling the readers about weekly payment mortgages, especially the accelerated weekly payment plan. Daily payment mortgages are also a possibility, but that’s another story. The writer quite obviously does not understand the time value of money. Time and money are exactly related by the laws of financial mathematics.
Prior to 1984 most North American mortgages were monthly payment mortgages. In June of 1984 a major Canadian lender introduced the weekly payment plan. Immediately, the President of a large real estate board was quoted or misquoted as saying, “I am always a wee bit leery of gimmicks” and he suggested just to double up the monthly payments. This is another example of the same mathematical ignorance, but in 1984. Twenty years later, people are still writing articles about doubling up on monthly payments as a realistic solution to minimizing interest costs. The best way to minimize your interest costs, is to pay back the loan as quickly as possible. The best way, specifically, to minimize your interest costs is to pay weekly payments and as large a weekly payment as one can afford.
The following example will prove my point. A Canadian mortgage of $150,000 at 7%, amortized for 25 years will require monthly payments $1,050.62 per month.
Paying a non accelerated weekly payment of $242.45 will save the borrower $3,249 in interest costs over the next 24.74 years. The $3,249 is “free money” given to you by the Bank. Simply put you have given the Bank the yearly total of 12 monthly payments but allowed them to withdraw it from your chequing account on a weekly basis. Any mortgage specialist worth their weight in Loonies should be telling clients to at least utilize this non accelerated weekly payment plan. Who wouldn’t want a gift of $3,249 for doing nothing? This “free money” or “savings” becomes even more attractive as the interest rates rise. At 14% the free money in this example is $27,230 and at 21% (as in early 1980s) the free money is $127,326 which is almost unbelievable, but true!!!
Obviously if a borrower can afford the accelerated weekly payment of
$262.66, a mere $20 per week more, the interest savings become $35,983
over the next 20.44 years. The 241.50 weekly payment saves $1,233 over
the full amortization period of 25 years. The $241.50 weekly payment is
derived by using any hand held financial calculator. To obtain the non
accelerated weekly payment multiply the monthly payment by 12 and divide
by 52. The accelerated weekly payment is arrived at by multiplying the
monthly payment by 13 and dividing the result by 52. The accelerated and
non accelerated weekly payments were arbitrarily selected in 1984 by a
major Canadian lender and have since become the defacto standard that
Canadian Banks adopted. To simplify the mathematics follow these steps.
Calculate the “normal” monthly payment first, or ask your
lender what the normal monthly payment would be for your conditions. Take
that monthly payment and divide it by 4.333 to calculate the non accelerated
weekly payment or divide it by 4.0 for the accelerated weekly payment.
Don’t try to use a financial calculator to calculate the non accelerated
or the accelerated weekly payment as the calculator wont be able to do
it. If a mortgage specialist does not inform you about these well established
weekly payment plans you should be a lot more than a wee bit leery! In
fact, you should change lenders.
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