There may be better, less expensive ways to own your home faster.
Typical Mortgage : 12 Payments Per Year
The typical mortgage asks for one payment per month, which equals 12 payments per year. With a 30-year fixed rate mortgage, therefore, 360 payments are required to pay the loan in full.
Each mortgage payment is split into two parts — a principal portion and an interest portion. The principal portion is applied to the amount that you owe the bank. This diminishes your remaining loan balance. The interest portion is your cost for borrowing from the bank.
As your loan moves toward maturity, the balance between your mortgage payments’ principal-and-interest shifts. In the early years, a significant portion of your payment is comprised of interest and just a small part goes to paying down your balance. It’s not until later in your loan’s lifecycle does the principal portion of the payment start to grow.
This repayment schedule is the reason why after 5 years or so, your loan’s balance has been barely paid down. The technical term for this repayment schedule is amortization.
Bi-Weekly Mortgage Payments : 13 Payments Per Year
A bi-weekly mortgage payment program is meant to short-circuit your loan’s amortization schedule. Instead of taking 12 payments per year, the bi-weekly payment plan asks for one payment every two weeks, which adds up to 13 payments per year.
Except that you can’t make 13 payments per year on your mortgage — that’s not how a mortgage works.
With a mortgage, you pay a certain amount of interest on an annual basis and that amount is covered in your first twelve payments. The 13th payment has to go somewhere, though, so it gets applied to your principal balance; the amount that you still owe to the bank.
And, this is how a bi-weekly payment plan works. With each “13th payment”, your loan balance is reduced by the entire amount of the payment. You reach your loan’s payoff date sooner.
At today’s mortgage rates, bi-weekly payments shorten your loan term by 4 years.
Effective Alternatives To Bi-Weekly Payments
Bi-weekly payments plans work; there’s no doubt about that. It’s just basic math. However, there are several reasons why homeowners may want to avoid enrolling in a bi-weekly mortgage payment plan.
The first — and most obvious — reason to avoid bi-weekly mortgage payment programs is that homeowners choosing to self-manage their bi-weekly payments get better results than via a bank-managed bi-weekly payment program.
Here’s how to self-manage: Rather than sending payments to the bank every other week, achieve the same result by making your regular mortgage payment once monthly, and adding 1/12 of your regular mortgage payment to your check.
For every $1,200 in your mortgage payment, in other words, add $100 to your monthly payment. By sending $1,300 to your lender monthly, you will “overpay” your mortgage by $1,200 annually, which is a 13th payment.
Assuming a $300,000 mortgage at 4.000%, look at how the math works:
- Bank-managed bi-weekly mortgage payments pays off in 26 years, 0 months
- Self-managed bi-weekly mortgage payments pays off in 25 years, 11 months.
This math works because banks don’t apply that 13th payment until the year is complete. By contrast, your self-managed system applies 12 times per year.
Another reason to skip the bi-weekly mortgage program is that bi-weekly payments are a contract and once that contracts starts, as a homeowner, you’re obligated to make those 13 payments per year no matter what.
By contrast, with a self-managed payment plan, you never have that obligation. You can choose to skip a month during the holidays, for example, then double-up on payments later on, or not at all. It’s all in your control — not the bank’s.
And, lastly, if you find your bank is charging for its bi-weekly mortgage payment program, make sure to say “no” no matter what. That’s just wasted money.
Compare Your Payment Schedule Options
Putting bi-weekly mathematics aside, the thing is, with mortgage rates low, your best alternative to the bi-weekly mortgage plan may be to get a new mortgage altogether.
Extra payments can speed up your payoff, but not as well as taking a zero-closing cost refinance, then putting your monthly savings back to your loan balance. Your payment stays the same, but your loan payoff date accelerates.
Assuming a 1 percent drop in your mortgage rate, the Refinance-and-Reinvest plan can shorten your loan’s term 63% more than a bi-weekly mortgage payment program ever could. Plus, with lower interest rates comes larger long-term savings.
Call me if you would like to check current mortgage rates and see how much you can save over the life of the loan.