About every three months, our mortgage lender sends us a letter. It’s to encourage us to pay our mortgage bi-weekly, instead of monthly. The pitch is simple. We would send off half of our normal mortgage payment every other week. That would make 26 annual payments, instead of 24 (12 months x 2). So we would end up making one extra payment per year. But why would we do that? By putting more towards our mortgage, we would own our home that much sooner. That would save us a bunch of interest over the long term.
I love the idea of paying off my mortgage earlier and paying less in interest. This method works especially well if you happen to get paid every other week. The budgeting becomes extremely easy. However, are these offers really all they’re cracked up to be? Here’s what you need to know if you too are thinking of changing to a biweekly mortgage plan.
Don’t Pay to Play
If you look at the fine print on some of these offers, there is often a very big catch. Some lenders ask for a several hundred-dollar fee to set this up for you. You’ll be paying that upfront, too. This might have made sense back in the dark ages of banking — before the internet made creating automatic payments a breeze. But in today’s digital world, there is absolutely no reason why you should pay the bank to set up something you can easily do yourself.
If you pay your mortgage through online direct payment, then you can create the exact same biweekly plan for free. Just change your monthly payment to include an additional amount equaling 1/12 of your normal payment. It will go directly to your principal. You can set that up once, and then be paying an additional month each year for the rest of your mortgage term.
One more thing to note about this. If you set your mortgage up as biweekly initially, then no problem. But if you want to change it in the middle.
You need to be careful here though. Some lenders will credit any extra payments you make towards the next payment. That means you aren’t really paying down principal, just merely paying the next payment early. The difference is subtle, but the result is that you still pay the interest you thought you were avoiding.
That’s why you need to check with your bank before you set this up. Some banks will require you to specify that the payment be made towards your principal instead of towards the monthly payment. If this is the case, all you have to do is setup two automatic payments. One for the regular mortgage installment, and a separate smaller withdrawal for the extra 1/12. Just make sure you note the second payment as one that goes towards your principal.
Alternatively, you could schedule a payment for half of your mortgage amount each time you get your biweekly paycheck. After a year, you will still get your extra payment in. This is because you receive three paychecks in some months, where you’ll be sending 1.5 times your normal payment. Doing so gets you the same result as having your mortgage due biweekly.
Avoid Being Locked In
One disadvantage to signing up for biweekly payment schedule is that you’re now required to pay every other week. If you send biweekly payments on your own initiative, you can always stop the practice if it no longer makes sense for you financially. However, if you sign a biweekly contract with your lender, you’re stuck with the payment plan. If you get paid every two weeks, it may not a problem. But if you encounter financial difficulties in a particular month, you might need more flexibility.
On the other hand, being locked in to build equity can work in your favor. If money is already taken out of your bank account for the mortgage before you even get a chance to see it, you won’t be able to spend it elsewhere. You have less money to spend, yes. However, you will build wealth faster because you will be forced to live life without that extra amount that’s now going toward building equity in your home.
Some Personal Examples
Here’s a tale of two neighbors, one of which is the store owner who told me their story. You see, they used to run a very profitable store. For them, money came pretty easy. They lived life without worry for a good many years. Their neighbors, however, worked a 9-to-5 job and seemed to have much less disposable income. That didn’t stop the dual income couple from trying to get ahead though. They used every penny they saved to buy into a retail plaza in the middle of nowhere (at the time). They continued to live like a pauper for decades, since the huge mortgage forced them to put most of their income towards paying down debt.
I’m sure it was tough on them for many years. However, building that equity paid off handsomely. A few decades later, the 9-to-5 couple is no longer working for a living. They live in a mansion in the nicest part of town with a paid off retail plaza that is worth more than $20 million dollars. The store owner (who told me the story) isn’t living on the streets or anything. However, he is still operating the store in his 70s in order to make ends meet. In fact, the store owner is now paying rent every month to his old neighbor.
Forcing yourself to build equity can pay off for you, if you play your cards right.
Low Rates Mean Less Savings
Biweekly mortgage payments tend to be much more attractive when interest rates are higher. For example, suppose you have just taken out a 30-year fixed mortgage at 7%. Paying that mortgage biweekly from the very beginning means you will have the home paid off in less than 24 years. It would save you over $33,500 in interest on every $100,000 of principal. That sounds like a great deal.
On the other hand, if the exact same loan has an interest rate of 3% (a rate much closer to what most homeowners are currently paying) it would take over 26 years for biweekly mortgage payments to eliminate the loan. Additionally, the diligent homeowner would only be saving roughly $7,139 of interest per $100,000 of principal.
While biweekly payments will help no matter what, they have a much more potent influence when interest rates are higher than they currently are.
The Bottom Line
If you are interested in paying off your home faster, then you should consider taking advantage of paying your mortgage biweekly. Just remember that it makes much more sense to simply do this on your own rather than lock yourself into a bank’s payment schedule. You don’t need to pay a fee for the privilege.
If you’re shopping around for an initial mortgage (or a refinance), take the time to consider all the different payment options. You can pay every month, on the 1st and 15th (bimonthly), or every two weeks (biweekly). Some lenders even offer “accelerated” payment schedules, where you can send a bit extra towards the principle every time you make a payment.
You might need the extra cash flow that comes with more spaced-out mortgage payments. Or maybe your primary goal is to build that equity as quick as possible. Compare these payment plans against your monthly budget, and make the best decision for yourself.