Bimonthly and Biweekly Mortgage Payment Plans
May 21, 2001, Revised November 30, 2004, March 22, 2006, November
21, 2006, October 15, 2007
Many lenders offer loan repayment programs that differ from the standard monthly payment arrangement. The inducement is an earlier payoff. These programs can be confusing, and the claims made for them are often exaggerated. The questions below illustrate three alternative payment schemes: bimonthly, biweekly and simple interest biweekly. Readers who want to dig deeply will find spreadsheets for each of these options at Spreadsheets.
“I have a 7% bi-monthly mortgage on which I pay 1/2 of the monthly payment on the 1st of the month and the other half on the 15th. The lender does not 'hold' the payment until the 30th, they apply it to principal right away. 24 payments are made each year, but the 30-year term is reduced to 23.5 years. What do you think?”
There isn’t anything wrong with the bimonthly, provided you didn’t give up anything to get it. Whoever told you that it would reduce the term of a 30-year loan to 23.5 years was blowing smoke. On a 7% 30-year loan, it takes 718 bimonthly payments, or 29 years, 11 months, to pay off. In other words, you knock just one month off the term.
A bimonthly mortgage involves no extra payments. You make 24 payments a year instead of 12 but they add to the same total. By advancing the payment by half a month, you save a little interest, which means that a slightly larger part of succeeding payments is used to reduce principal.
The effect, however, is small. A standard $100,000 loan at 7% for 30 years would have a balance at the end of year one of $98,984.19. The same loan cast as a bimonthly would have a balance of $98,982.66, or only $1.53 lower. The difference grows over the years, but only by enough to knock one month off the term.
A biweekly mortgage is one on which the borrower every two weeks makes a payment equal to half the monthly payment on a standard mortgage. The payment amount on a biweekly is thus the same as that on a bimonthly. But since there are 26 biweekly periods in a year compared to 24 bimonthly periods, the biweekly produces the equivalent of one extra monthly payment every year.
This results in a significant shortening of the term. For example, the 7% 30-year loan converted to a biweekly pays off in 287 months – or 23 years, 11 months. The reduction in term is due entirely to the extra payment every year.
On a standard biweekly, the biweekly payments are credited to an account managed by the lender or by an intermediary. The lender or intermediary makes the monthly payment out of the account on the first of the month, just as the borrower would do on a standard mortgage. The interest earnings on the account belong to the lender or intermediary. When a year has elapsed, the excess amount accumulated in the account is equal to a full payment. It is only at this point that the lender makes a double payment that depletes the account.
“I have been offered a simple interest biweekly mortgage that is said to be much more powerful than conventional biweeklies because the payment is applied to principal right away…I don’t understand the difference.”
The difference is that the payment is applied to principal every 2 weeks, rather than every month. This results in a faster payoff for the same reason that a bimonthly pays off faster than a standard mortgage. Again, however, the difference is small. Where a 7% 30-year standard biweekly pays off in 287 months, the version on which the payment is applied every two weeks pays off in 284 months.
Readers who want to examine this difference further should examine my calculators 2b, Mortgage Prepayment Calculator: Biweekly Payments Applied Monthly, and 2bi, Mortgage Prepayment Calculator: BiWeekly Payments Applied Biweekly. They show you exactly what the differences are and how they come about.
Borrowers who like the idea of accelerating the payoff need not pay extra for the privilege; they can do it themselves. By making a double-payment once a year, they will pay off just as if they had a standard biweekly on which payments are applied monthly. Alternatively, by increasing their monthly payment by 1/12, they will pay off almost as if they had a biweekly on which payments are applied biweekly. For further discussion, see Do You Need Help to Repay Your Mortgage Early?
In sum, assuming knowledgeable borrowers, the only ones who should opt for an alternative payment plan administered by the lender or a third party are those without the discipline to stick to a plan of their own.
Many lenders offer loan repayment programs that differ from the standard monthly payment arrangement. The inducement is an earlier payoff. These programs can be confusing, and the claims made for them are often exaggerated. The questions below illustrate three alternative payment schemes: bimonthly, biweekly and simple interest biweekly. Readers who want to dig deeply will find spreadsheets for each of these options at Spreadsheets.
Bimonthly Payment Plans
“I have a 7% bi-monthly mortgage on which I pay 1/2 of the monthly payment on the 1st of the month and the other half on the 15th. The lender does not 'hold' the payment until the 30th, they apply it to principal right away. 24 payments are made each year, but the 30-year term is reduced to 23.5 years. What do you think?”
There isn’t anything wrong with the bimonthly, provided you didn’t give up anything to get it. Whoever told you that it would reduce the term of a 30-year loan to 23.5 years was blowing smoke. On a 7% 30-year loan, it takes 718 bimonthly payments, or 29 years, 11 months, to pay off. In other words, you knock just one month off the term.
A bimonthly mortgage involves no extra payments. You make 24 payments a year instead of 12 but they add to the same total. By advancing the payment by half a month, you save a little interest, which means that a slightly larger part of succeeding payments is used to reduce principal.
The effect, however, is small. A standard $100,000 loan at 7% for 30 years would have a balance at the end of year one of $98,984.19. The same loan cast as a bimonthly would have a balance of $98,982.66, or only $1.53 lower. The difference grows over the years, but only by enough to knock one month off the term.
Biweekly Payment Plans, Payments Applied Monthly
A biweekly mortgage is one on which the borrower every two weeks makes a payment equal to half the monthly payment on a standard mortgage. The payment amount on a biweekly is thus the same as that on a bimonthly. But since there are 26 biweekly periods in a year compared to 24 bimonthly periods, the biweekly produces the equivalent of one extra monthly payment every year.
This results in a significant shortening of the term. For example, the 7% 30-year loan converted to a biweekly pays off in 287 months – or 23 years, 11 months. The reduction in term is due entirely to the extra payment every year.
On a standard biweekly, the biweekly payments are credited to an account managed by the lender or by an intermediary. The lender or intermediary makes the monthly payment out of the account on the first of the month, just as the borrower would do on a standard mortgage. The interest earnings on the account belong to the lender or intermediary. When a year has elapsed, the excess amount accumulated in the account is equal to a full payment. It is only at this point that the lender makes a double payment that depletes the account.
Biweekly Payment Plans, Payments Applied Biweekly
“I have been offered a simple interest biweekly mortgage that is said to be much more powerful than conventional biweeklies because the payment is applied to principal right away…I don’t understand the difference.”
The difference is that the payment is applied to principal every 2 weeks, rather than every month. This results in a faster payoff for the same reason that a bimonthly pays off faster than a standard mortgage. Again, however, the difference is small. Where a 7% 30-year standard biweekly pays off in 287 months, the version on which the payment is applied every two weeks pays off in 284 months.
Readers who want to examine this difference further should examine my calculators 2b, Mortgage Prepayment Calculator: Biweekly Payments Applied Monthly, and 2bi, Mortgage Prepayment Calculator: BiWeekly Payments Applied Biweekly. They show you exactly what the differences are and how they come about.
Accelerated Payment Plans in Perspective
Borrowers who like the idea of accelerating the payoff need not pay extra for the privilege; they can do it themselves. By making a double-payment once a year, they will pay off just as if they had a standard biweekly on which payments are applied monthly. Alternatively, by increasing their monthly payment by 1/12, they will pay off almost as if they had a biweekly on which payments are applied biweekly. For further discussion, see Do You Need Help to Repay Your Mortgage Early?
In sum, assuming knowledgeable borrowers, the only ones who should opt for an alternative payment plan administered by the lender or a third party are those without the discipline to stick to a plan of their own.