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13 Payments Per Year

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THE SCENARIO A money-saving or debt-reduction strategy I've heard many times is some variant of 'make an extra payment every year on your mortgage to pay it off faster'. Sometimes, this is couched in making a half-payment every 2 weeks (which adds up to 13 full payments every year), but the end result is the same: paying extra principal in order to shorten the total time it takes to pay off the loan (and reduce the amount of interest you ultimately end up paying). To keep things simple, we're going to figure out the effect of making an extra payment every year, but spread evenly as extra principal paid every month (i.e. take the extra payment, divide it by 12, and add the result to each normal payment). I'll call this the 'enhanced' payment throughout. The question: If I have a 30-year fully amortizing mortgage for $220,000 at 4.75%, how long would it take me to pay off the loan if I were to make this extra payment every month?

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THE SOLUTION This problem has 3 steps:

1. Figure out my normal payment.
2. Figure out what my enhanced payment should be.
3. Figure out how long it will take me to pay off the loan with the enhanced payment.

First things first, make sure the calculator is using 12 Payments per Year. Step 1: Figuring out my normal payment N: 360 (It's a 30-year loan) I/YR: 4.75 (The interest rate on the loan is 4.75%) PV: 220,000 (I borrowed $220,000) PMT: (This is what I'm trying to find) FV: 0 (The loan amortizes fully)

My normal monthly payment is $1,147.62.

Step 2: Figuring out what my enhanced payment will be Every month, I want to pay an extra 1/12 of my normal payment. $1,147.62 ÷ 12 = $95.64. So my enhanced payment is $1,147.62 + $95.64 = $1,243.26 Step 3: Figuring out how long it will take to pay off with the enhanced payment N: (This is what I'm trying to find) I/YR: 4.75 (The interest rate on the loan is 4.75%) PV: 220,000 (I borrowed $220,000) PMT: -1,243.26 (My enhanced payment is $1,243.26) FV: 0 (I want to know how long it'll take to fully pay off the loan)

Using the enhanced payment, the loan will be paid off after 305.14 months (25.43 years).

Next time, we'll look at more dramatic example of using this technique, and take it one step further - calculating how much money we'll save by making the enhanced payment.

What do you think? Would you make (effectively) an extra payment every year to shave off 4½ years? Why or why not? Let us know in the comments!