Understanding Bi-Weekly Mortgages – Guest Post
Written by: Gary Foreman
The Dollar Stretcher Blog
Dear Dollar Stretcher,
I read as article about “Biweekly Mortgage Payment Programs” and I have a question. I have read that I can do the same thing myself by just paying an extra payment every year for the same affect so why should I pay someone else to do this?
The thing that I don’t understand, is how is it beneficial for me to buy the service when I didn’t have to? I owe $276k and can do the biweekly for set up fee of $375 and $3 a month. I will shave 6 yrs and 4 months off of my mortgage. I have 27 years left. So over the course of this loan, I pay them about $1k to do this. In the meantime, I save $87k in mortgage payments and 6 yrs. But aren’t I really paying them $1k for something I could do myself?
If I didn’t go with them, I would end up paying an extra payment a year split up monthly, that would amount to about 2k a year. So if I did this, I would end up saving $87k in interest and 6 yr, but I would have paid $40k in extra payments. Am I wrong in seeing it as $40k versus $1k?
Eric
It has been said that the key to most magic is to distract your attention from what is really happening. While you’re looking one way, the real action is happening somewhere else. The same is true for many financial offerings. The salesman is so busy pulling rabbits out of a hat that it’s hard to pay attention to what’s important.
And, when you look at something like a bi-weekly mortgage plan, there does seem to be a lot of rabbits hopping around. So let’s see if we can’t trap a couple of bunnies and determine what’s really happening with a bi-weekly mortgage plan.
Rabbit #1. The length of your mortgage. Any prepayment of principal will reduce the life of your mortgage. Larger prepayments will have a greater effect than smaller prepayments. And, prepayments made in the early years of a mortgage have a bigger effect than the same prepayment made later in the life of the loan. That’s true whether you make the payments yourself or have someone do it for you.
Rabbit #2. 12 months = 52 weeks. You knew that one. Eric points it out, too. Making half of your monthly mortgage payment every two weeks is the same as adding one extra monthly payment per year. Or adding 1/12th of a monthly payment to each regular monthly payment. You don’t need anyone to do that for you.
Rabbit #3. Bi-weekly mortgage payments don’t create free money. If your monthly mortgage payment is $2k, by going to a bi-weekly program you’ll need to find an extra $2k in your budget each year to add to your mortgage payments.
Rabbit #4. Service fees. Any money paid to the company setting up the bi-weekly program doesn’t go to pay your mortgage.
Rabbit #5. Making two payments a month. Paying half of your monthly mortgage payment two weeks early will reduce the length of your mortgage. But not by a significant amount.
OK, so let’s see if we can’t help Eric to focus on what’s really happening with a bi-weekly mortgage. He’s exactly right in that by going bi-weekly it has the same affect as making an extra payment each year.
In this case about one extra $2k payment for about 20 years. And, that will be true whether Eric goes bi-weekly or just adds 1/12th ($166) to each monthly payment himself. So if he reduced the legnth of his mortgage to 20 years he’ll be putting in about $40k in total prepayments.
If he works with the bi-weekly mortgage company he’ll also end up paying them about $1k.
In either case he says that he should reduce about $87k in interest that he won’t have to pay the mortgage company.
So the real difference is whether he wants to pay $1k to have someone to perform the service for him. In fairness, companies offering bi-weekly mortgage plans do provide some services to earn their pay. The biggest one is that they make sure that the mortgage company applies the proper amount to reducing principal each month.
But you can do that yourself. Just a matter of checking your principal balance after your payment is applied and make sure that it was reduced by the amount of any prepayment plus the portion of your regular payment that goes to principal.
So to answer Eric’s question – it would cost him about $1k for something that he could do himself. Being frugal, we’d just add the extra amount to each monthly payment and skip the bi-weekly business. But, if Eric needs the extra discipline, then spending $1k to save $87 isn’t a bad deal.
Keep on Stretching those Dollars!
Gary
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Gary Foreman is the editor of The Dollar Stretcher.com website and various enewsletters. Visit the site for more info on mortgage prepayments. Send your frugal living questions to gary@ stretcher.com.
Tagged with: Bi weekly mortgages • Budgeting tips • loan payoff • personal budget planning • personal budgeting • Web Page Finance
Filed under: Home Finance & Insurance
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Thanks so much for this information. For the most part I would say that keeping the traditional mortgage and then just adding a little bit here and there as you can is the best way to go. I say that because I am off on disability and am struggling to keep the mortgage in place that I have already. This is even though I do not have a teaser loan – it just causes a lot to be sick. When I get back on my feet, I will start in adding principle reductions, but I want to have cash built up first.
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The amount of effort Eric would save definitely does’t warrant the service fee. I learned a lot from your article. Thanks for posting.
The amount of effort Eric would save definitely does’t warrant the service fee. I learned a lot from your article. Thanks for posting.
My wife and I prepay our mortgage religiously, but I like the ability to self-amortize it without any specific rules or regulations. That’s why I’ve never signed up for any of these bi-weekly programs of any sort.
We contemplated getting a 15-year mortgage, but the decrease in interest rate didn’t offset the flexibility we’d lose if we ever needed to pay the smaller amount.