Most people pay their bills monthly, because that corresponds to when you get paychecks from your job. But insurance companies and certain other service providers sometimes offer you the chance to make a single up-front annual payment, and they might even give you a discount to do so. If you can afford to pay your debts in big lump sums, then the question becomes whether the discount is big enough to make it worth your while to pay in advance. The calculator toward the end of this article will help you with that calculation but, first, you'll learn more about situations in which this scenario comes up.
When you can make annual or monthly payments
The most common expenses in which you can often choose between annual or monthly payments are insurance premiums. Whether it's your auto or homeowners insurance, most companies calculate premiums on an annual or semiannual basis. But to make it easier for their customers, they also let you pay your premiums monthly. Some companies structure those monthly payments with an added convenience fee, while others give a discount for paying up front on an annual basis. Regardless of the method, the net result is that you'll pay less for an up-front payment than you would if you stretch it out monthly over the course of six months or a year.
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If you own a business, then you might need to consider this question in reverse. With any service for which you offer customers an annual subscription, you can either charge the full amount at the beginning or take monthly payments over time. Having more money in the beginning is more beneficial to you, but if accepting monthly payments gets you more customers, that might be the best way to maximize your business profits.
The math behind annual and monthly payments
If you think about it, offering monthly payments is equivalent to giving the customer a loan for the amount of the annual subscription. For example, if an insurance company charges $1,200 per year for premiums and lets you pay it $100 per month, then you're essentially borrowing $1,100 at the beginning of the year and paying it back monthly over time. If the cost of the monthly payments just adds up to the total annual cost exactly, then that loan is interest-free. But if you can get a discount by paying up front, then that loan actually has a cost, and you can figure out the equivalent interest rate. That's what the calculator below does.
Editor's note: The following language is provided by CalcXML, which built the calculator below.
* Calculator is for estimation purposes only, and is not financial planning or advice. As with any tool, it is only as accurate as the assumptions it makes and the data it has, and should not be relied on as a substitute for a financial advisor or a tax professional.
A simple example
To see how this calculator works, let's use a basic example. Say that your insurance company gives you two choices with your annual premium. You can either pay $1,150 in a single payment at the beginning of the period or you can pay $100 per month for 12 months.
When you run those numbers through the calculator, you'll find that you'll pay $50 more over the course of 12 months using the monthly payment figure than you would if you paid it all up front. The calculated annual percentage rate is 9.4%, which means that if you went and borrowed $1,150 for a year at 9.4%, the interest would be such that the monthly payments to pay off the loan in 12 months would be $100.
If the interest rate is less than what you'd pay on a credit card or other loan to pay the balance up front, then it makes sense to use the monthly method. If the rate is more than you'd pay from other financing, then you should borrow using that alternative financing source and make a single annual payment.
Few people consider the fees and other charges of monthly installment plans with insurance and similar bills, but there's often a very real cost to using them. By knowing what those costs actually are, you'll be better able to decide whether paying them is worth it to you.
