Numbers make my brain go Wugga Wugga
April 22, 2010 12:06 PM   Subscribe

[Money Filter] Help me pay off this loan wisely.

DISCLAIMER: I've been through a bunch of Ask MeFi questions and I see that is recommended a lot, but I didn't seem to find anything or any calculator that would answer my question. Or maybe I'm not asking the right question? Also I'm seriously retarded when it comes to math and numbers and I'm fine with that -- I have other talents.

Whew, that said, here's my question:

I have a a new signature line of credit through my credit union that I used to do some work on my house.

The interest is calculated daily. When I make a payment, it pays the interest due up to that date and then applies the rest to the principal. So no matter how many payments per month I make, they take X amount for accumulated daily interest each time. I cannot pay the amount due and then a week later make another payment and say, "apply this amount to principal." I'm sure this is called something, I just don't know what.

The payment due is $118 per month, due on the 25th of each month. My current plan is to set up online banking to automatically pay $125 every other Friday (payday), which is what I can comfortably afford. It occurs to me that this may not be the wisest way to pay it off. Of course I want to pay down the principal as soon as possible.

With that in mind do I:

1. Wait and pay the entire $250 on the due date?
2. Keep paying $125 every other Friday (PayDay)
3. Pay $62.50 every Friday?
4. It just doesn't matter?
5. or something else I'm not thinking of..?

Thanks, you wonderful AskMefiers, you.
posted by trixare4kids to Work & Money (10 answers total) 2 users marked this as a favorite
Pay the $125 twice a month if that automated payment scheme will keep you on track.

I'm not clear on what you think isn't wise about that plan. It seems wise to me.

Of course, the higher your payments the faster you pay off the principal and hence the less interest you pay over the life of the loan.

Perhaps this is beyond what you're interested in, but have you built a loan amortization table in Excel? This can help you track the life of your loan and its remaining balance.
posted by dfriedman at 12:11 PM on April 22, 2010

Response by poster: Hrm.. maybe I wasn't too clear in my question. If the interest is charged daily and so they take out the accumulated interest with every payment, would I see any savings (pay less interest over time) by breaking it up into 4 payments of $62, or paying it all on the due date or whatever.

I can set up the online banking to do whatever I want very easily, I just want to set it up so that I pay the least amount of interest over time or.. pay the principal down faster or.. something like that. I'm fumbling around here because I don't know terminology. I'm not even clear if it actually matters how I pay it, that's what I'm trying to figure out.
posted by trixare4kids at 12:17 PM on April 22, 2010

It sounds like the monthly payment is $250 (is this principal + interest), and that you've concluded that you just want to pay off the loan as fast as possible.

If you're talking about paying the SAME amount of money, just spread over the month, the benefit is the interest rate on that money over the course of a month. So assuming money-market type rates of return, for $250 per month, you're looking at saving maybe $5 over the course of a year by "accelerating" payments.

If you are thinking about making payments of $125 every two weeks when the loan only requires a payment of $250 per month, that gets the loan paid off faster because the "biweekly" payments result in MORE than $250 per month being paid, since that's effectively an "extra" payment every now and then.

Whether or not it makes sense to pay off the loan sooner rather than later would depend on the principal of the loan, what is the interest rate, and what (if any) prepayment penalty there is. But if it's just a matter of timing the $250 monthly payment, then I think you may be beanplating this for savings of a few buck a year.
posted by QuantumMeruit at 12:18 PM on April 22, 2010

Oops, I should have previewed / read closer. I see that the monthly payment is $118 and you really want to make a payment of $125 every other week.
posted by QuantumMeruit at 12:20 PM on April 22, 2010

If the interest is computed and charged daily, then yes, you will pay less interest if you pay $125 twice a month than $250 once a month.
posted by Perplexity at 12:21 PM on April 22, 2010

OK, I get it...

Perplexity is correct that the $125 payment 2X a month will incur less interest over the life of the loan than a single $250 monthly payment would, assuming daily compounding.
posted by dfriedman at 12:37 PM on April 22, 2010

Best answer: I apologize for giving a bad / unclear answer earlier.

Here's what I should have said.

If you make two $125 payments a month, your second payment in the month would allow you to avoid paying 14 days of interest. This saves you about 24 cents a month assuming a 5% interest rate on the loan. (I also assume simple interest; doing the calculations for compound interest would add a few cents in savings each month.)

So yes, making more frequent payments incurs less interest over the life of the loan, but given the amounts involved, the savings are fairly small. The savings are even smaller if the extra money you would have paid earns interest (i.e., if it's in an interest-bearing money market account).

You may have seen "biweekly" mortgage payment programs. In these programs, you pay half of your mortgage payment every two weeks. The "magic" is because over the course of the year, you are making MORE payments than you would if you just paid every month.

EXAMPLE: If you pay $125 every other Friday, in the months of May, June and July 2010, you would make seven payments of $125 (for a total of $875). If you paid $250 every month, you would only pay $750 (because over that period you'd make 3 payments of $250).
posted by QuantumMeruit at 12:51 PM on April 22, 2010 [1 favorite]

Best answer: If the interest is computed and charged daily, then yes, you will pay less interest if you pay $125 twice a month than $250 once a month.

But difference would be a ridiculously small amount, especially once a decent amount of the principal is paid down. Daily interest is usually charged at the formula (Days since last payment) * (Outstanding principal) * (Annual interest rate / 365).

So if are paying once a month with $10,000 left at 5%, that gives you (30) * ($10,000) * (0.05 / 365) = $41.10 in interest paid. If you switch to two payments, that's (15) * ($10,000) * (0.05 / 365) = $20.55 and (15) * ($10,000 - ($125 - $20.55)) * (0.05 / 365) = $20.33, or a total of $40.88, giving you a total savings of $0.22 per month in interest. As the principal gets lower, the amount that you save from doing this will drop.

Stop worrying about how much you are losing from daily interest calculations, and focus on paying as much as you can each month. Making a one-time payment $20 right now will probably save you more money over the life of your loan than paying two payments a month instead of one for the rest of the time.
posted by burnmp3s at 12:52 PM on April 22, 2010

As the principal gets lower, the amount that you save from doing this will drop.

Actually scratch that, the amount you save will mostly stay the same over the course of the loan. The rest of it should be correct though.

And QuantumMeruit was correct in mentioning that your savings account rate if any would factor in to the real savings, and that bi-weekly payments will have more payments in a year than paying twice monthly.
posted by burnmp3s at 1:14 PM on April 22, 2010

Response by poster: Thanks everyone, so I will simply keep making bi-weekly payments of $125.
posted by trixare4kids at 2:09 PM on April 22, 2010

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