In a pamphlet mailed out to potential home buyers, “Terminology Tip” for home buyers there was a confusing statement. The intent of the article may have been to dumb it down for the lowly consumer. The TIP alluded to the incorrect notion, an extra monthly payment each year is as good as a biweekly payment mortgage. A biweekly payment mortgage is better than a monthly payment mortgage because the payment frequency is greater. The sooner a payment is made (by making more payments per year) the less time the interest has to accrue! Because the payment frequency is greater, less time is allowed before an interest and principal payment is made. When money is borrowed and interest clock starts ticking. The longer you wait to pay the interest the larger the interest costs. Once the interest is calculated and taken the balance of the payment goes towards reducing the principal.

A 100,000 mortgage example will be used with an annual interest rate of 6% utilizing monthly compounding with biweekly payments of $500. Thus at the end of one year the biweekly payment mortgage will have 26 x $500 = $13,000 in payments. This biweekly is compared to a mortgage that has thirteen payments per year in the amount of $1000 per payment (every 28 days approximately) therefore the same yearly cash flow.

A traditional monthly payment, monthly compounding mortgage has the monthly interest factor calculated by dividing the annual interest rate by 12. In this 13 payment per year mortgage (payment every 28 days) the annual interest rate is divided by 13. The interest factor for a 28 day period is .06/13 = 0.00461538461. Monthly compounding was purposely chosen for simplicity in calculating the 28 day interest factor, even though most Canadian mortgages use semi-annual compounding. The difference between monthly and semi-annual compounding in this example is not significant in the explanation. The monthly compounding interest factor is easier to visualize for a novice.