Paying down loans multiple times per month?

Should one pay down loans multiple times per month?

Most Americans get paid either bi-weekly or semi-monthly. That means that most people either get paid every 2 weeks or 2 times a month. Why is this important? It is important because of compounding interest. I've yet to discuss compounding interest in this blog but compounding interest can work for you or it can work against you. If we are talking about investments say like to a mutual fund, then compounding is great. If we are talking about student loans, credit cards or mortgages then compounding is working against us. 

When we look at loans we see something called an APY. APY stands for Annual Percentage Yield. This is essentially the interest you would expect from an investment vehicle (savings account, money market account, CD...) if you were to leave your money AND ITS GAINS there for a whole year. Whats actually happening is that each monthly disbursement of interest will be added to the compounding and at the end of the year your principal PLUS the compounding interest through out the year will equal to your APY. 

The magic here is the fact that the money gets compounded daily. Meaning that every single day that your money sits there you are gaining interest. The issues happens when you are on the other side of the equation and you are the one paying the interest. 

As an example imagine that you put $1,000 into a savings account. And you are told that the APY for the savings account is 3%. One would assume then that the monthly rate (since a bank pays and compounds it on a monthly basis). But if you divide 3% by 12 months that is 0.25%. But notice how the monthly rate is actually 0.246%. The reason why the monthly rate is lower than our calculated 0.25% is because the bank is counting on a monthly compounding to make up the difference. When you are the saver then it literally pays to keep your money in the bank. But when you are talking about a loan you don't want it to take advantage of daily compounding. Therefor, if you get paid more than once a month you should be trying to put money towards your loan just as often to minimize the compounding therefore decreasing your own APY.

Implementing this little hack equates to a non trivial amount of money being saved without having to use additional dollars... Just pay them more frequently. To see how much you would save checkout this calculator https://www.mortgagecalculator.org/calcs/biweekly.php

So should we pay down our loan more than once a month? YES! You should pay down your loan the second you have money to do so, don't wait till the end of the month, don't wait for the loan to compound.

Becoming financially independent is all about taking a lot of little calculated decisions that will lead you to success.