Change the date for big savings

 

MORTGAGE REPAYMENTS:HOW WOULD you like to knock as much as 20 per cent off the cost of your mortgage without breaking a sweat? Believe it or not, it can be done – and it is not hard – yet for reasons that are beyond us, virtually no one is doing it.

Irish consumers are conditioned to pay their mortgage on a monthly basis but this can cost a lot of money. If, instead of paying monthly, you pay your mortgage every two weeks then you could easily dramatically cut its cost over the full term.

If someone has a €300,000 mortgage taken out over a 30-year term and they make a monthly repayment, it will cost €1,610.46 every month, based on an average interest rate today.

If they pay fortnightly, it will cost them €805.23 each time.

But when a person pays monthly, the total interest on that loan over the full 30 years is €279,767.35 or €777.13 a month. If, however, that person pays off the mortgage every fortnight then the total interest falls to €226,466.56 or an interest payment every bi-weekly period of €289.60.

The reason the interest falls so substantially is very simple.

Most banks calculate mortgage interest on a daily basis. If you owe €100,000 and pay off €1,000 monthly, a bank will calculate the interest owed on the full amount of €100,000 at the end of that first month. But if you pay off €500 every fortnight, then for the second half of that first month, the amount of interest you pay is less because for two of the four weeks, the capital owed is €99,500.

Spread that over the 30 years and the savings really mount up.

“The mortgage holder could knock almost €54,000 off the cost of their loan,” says Frank Conway, director of moneycoach.ie.

If you pay €500 every two weeks however, you end up making 26 payments each year which is €13,000 a year. The extra amount comes directly off the loan principal which reduces the amount on which any future interest is going to be calculated.

Because the interest is less, the more of each future repayment goes towards the principal which means that the interest is less and before you can say “negative equity, what’s that?” your mortgage has been cleared. In this scenario you will pay a little bit more, admittedly, but it could be worth it to cut years off the term of your mortgage.

“Because of the way people get paid, they tend to just pay monthly and the banks are happy to take monthly repayments because it cuts down on their administrative costs,” says Karl Deeter of Irish Mortgage Brokers.

He says switching to twice monthly payments makes sense. “It is a cracking idea if your bank will let you do it.” We contacted the banks to see if they have any issue with people switching from monthly payments to twice-monthly ones.

What was interesting was that none of the bank officials and spokespeople we contacted seemed aware of the potential savings that could be made.

By and large, the banks said it would be okay to move to twice-monthly payments.

Hardly surprising as it can help them raise capital more quickly. And if there is one thing Irish banks need, it’s capital.

Ulster Bank says customers can pay off their mortgage as often as they like, although they will not accept any more than one direct debit payment a month. Similarly with KBC. It said its customers could pay their mortgage monthly as is normal practice but said it “offers customers the option of making additional payments to their mortgage on an adhoc basis as a lump sum or an extra monthly repayment in addition to their scheduled monthly repayment”.

Permanent TSB allows its customers to switch to twice-monthly payments but the bank says it cannot handle direct debits twice a month so customers would have to cancel their direct debit and set up a standing order in its place. The problem with standing orders, however, is that they are for fixed amounts which cannot be changed by the bank so should interest rates rise – and interest rates are going to rise – it will be the responsibility of the mortgage holder to change their direct debit. For its part, Bank of Ireland says its customers could pay their mortgages on a fortnightly basis.

“If a customer wishes to do this they must send a request in writing to the bank, signed by all parties,” a spokeswoman said.

AIB says there was no problem with twice-monthly payments either.

Another option for people who want to cut the cost of their mortgages, is to take out a 30-year mortgage but pay it off over 15 years. It is hardly surprising that sounds painful, because it is. But, according to Conway, it is not, perhaps, as painful as you might imagine. He says most people think that if they cut the loan term in half they will double their repayments but that is not the case.

Let’s say you have a €300,000 mortgage and are paying a rate of interest of 5 per cent. “Paying on a 30-year term, the monthly repayment is €1,610.46,” Conway says. This means the total cost of the interest is €279,767. Paying on a 15-year term, the monthly repayment is €2,372.38, so the total cost of the interest is €127,028 ”

So, buying the same home with the same rate of interest on the mortgage to finance the purchase, a customer taking out a 30-year mortgage but paying it off over 15 years can save themselves €152,737 in interest charges. The house costs them almost €153,000 less than financing over a 30-year term although they do pay 47 per cent more per month which may be hard for a lot of people to stomach in the current climate.

* This article was amended on April 4th, 2011. In the original, it incorrectly stated such savings would come at no additional cost to the mortgage holder. While some small savings can be made by simply splitting payments from monthly to twice a month, they are small as the mortgage holder is not paying off the capital any faster .

The savings alluded to in the original piece only accrue because a person pays 26 fortnightly payments as opposed to 12 monthly ones, effectively making an extra four weeks’ payment each year, which should come off the capital. By switching to the fortnightly payment, a person can knock several years of a 30-year mortgage. 

I know what a tracker is . . . so I'm keeping it

The big question many people might have about switching to different payment dates is what impact it could have on their precious tracker.

Banks are using – or are at least trying to use – all sorts of spurious reasons to move people off tracker mortgages because they are cost the banks money. And if there is one thing our banks do not have right now, it is money.

Trackers became hugely popular in this country after the Bank of Scotland arrived in the late 1990s and started throwing them around like confetti at a wedding.

Irish lenders were terrified they would lose market share to the interloper and introduced tracker deals of their own, some of which were ridiculously generous.

At the height of the boom, trackers for less than one per cent over the European Central Bank base rate of lending were available.

Irish banks are now charging some consumers a rate of less than two per cent for money which is costing them over five per cent to borrow, which is why many are using the most flimsy of pretexts to try and convince people to surrender them.

The bottom line is that consumers who ask to switch to twice-monthly payments, instead of monthly ones, are under absolutely no obligation to abandon their tracker and any bank who even mentions that as a possibility should be roundly condemned.