In my last post I mentioned, the idea of getting on a bi-weekly payment plan. To be honest, I have always paid rent in bi-weekly installments so that we didn't have to take a huge hit on one paycheck and then have to make the second check of the month last the rest of the time. So, for our $750/month rent, I pay $375 from the first check and $375 from the second check. Now, as long as I am renting, this doesn't make any different at all in my debt. However, on the average 30 year mortgage, it is possible to cut 5 years off of your loan by paying bi-weekly instead of monthly, AND you can save tons of money in interest!!!
Consider this: if you are paid every other week, you will receive 2 paychecks per month on average. However, there are always exactly 2 months out of the year where you will receive a third paycheck. So, when I pay my rent bi-weekly, the effect is that at the end of the year I have paid an extra full month of rent because I still set aside that $375 every paycheck, whether I got 2 checks or 3 in that particular month. When it comes to debt, that means that you made a full month extra payment just by splitting your regular payment in two and paying that amount every time you get paid. Now, you would think that this would not make such a big difference because it is only one extra payment in a year, so it would theoretically take you 12 years to make 12 full extra payments, and cut off a year, but this is a logical fallacy of sorts. In fact, making bi-weekly payments actually has an even bigger impact on your loan because it disrupts the interest accrual on your loan every 14 days.
What I mean by disrupting the interest cycle is that over the course of a single month you may accrue X amount of interest normally on your loan. By splitting your payment, you are only accruing 1/2X for the first half of the month, and then your payment is paying off that interest and partially being applied to your principal as well. So for the second half of the month, your interest is even smaller because it is based on a smaller principal loan amount. That means that every 14 days you are paying off the interest and putting a dent in the principal that lowers your interest for the next 14 day period. At first this may seem like you are making a tiny difference, perhaps only a few cents at a time. On the other hand, on a 30 year mortgage of a $200,000 house, it can add up to nearly $34000 in savings over the course of the entire loan.
Now, there is no reason this won't work on student loans like it works on mortgages. In fact, I found that I was able to search for "biweekly payment calculator" on yahoo, and came up with a few different choices. I re-purposed them by putting in our student loan information instead of mortgage information, and was able to see how much I would save by using this method even on the smaller scale. For instance, the AES loan (which now sits at $27,929 and 6.71%) is estimated to be paid off in 2029 on the current repayment plan. With the snowball method I was able to save 7 years on that and move it up to 2022. And with the bi-weekly payment plan I can potentially cut another 2 1/2 years off!!!! That is 9 1/2 years off of a loan that was on a 25 year repayment plan originally! The bi-weekly payment plan will save us $2400 in interest by itself, without counting the interest saved by the snowball method.
This doesn't just apply to big loans either. It can be used for anything at all. Naturally, the bigger your starting balance is, the bigger a difference it will make, but any time and money you can save is completely worth it to me!
Anyways, the point of this post is that even if you are not able to set aside a lot of extra money to make bonus payments with the snowball method, you may be able to make a substantial difference just by splitting your payment between two checks instead of paying it all at once. (I have also found that if you split your payment, you are more likely to make a small bonus payment of $5 or $10 each time because you won't be taking such a huge hit to any single check.)
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