Do You Need Help to Repay Your Mortgage Early?
April 20, 1999, Revised October 16, 2007,
Reviewed January 10, 2011
Biweekly payment plans offered by lenders and third parties impose a savings discipline on borrowers that may be useful, but borrowers who don't need the discipline can roll their plan. They can make extra payments to be applied to principal whenever they receive a bonus or some other windfall. Or they can add a fixed amount every month to their scheduled payment. If they add 1/12 of the payment, they will pay off the loan a little earlier than with a biweekly.
"A broker suggests that for only $350 I can convert my existing mortgage to a biweekly mortgage that would pay off the loan in 20 years rather than 30 and save $65,000 in interest payments. It looks like magic…Am I missing something?"
I have another deal for you. Pay me $350 and I’ll arrange for you to pay half of your monthly electrical bill every two weeks. At the end of a year, voila!, I will produce a bonus for you equal to an average month’s bill. And I’ll keep generating the bonus year after year. Do we have a deal?
The "magic" in both deals is paying half the monthly payment every 2 weeks, which results in an extra monthly payment every year. (Twenty-six payments, each one for half of one monthly payment, is the equivalent of 13 monthly payments rather than 12). This extra payment is the magic that pays off a biweekly mortgage early, but you need not pay anyone to do the trick for you.
The biweekly mortgage dazzles a lot of people because they confuse the interest payments over the life of the loan with the interest rate. Total interest payments paid over the life of a loan depend on the rate, on the amount borrowed, and on how rapidly the loan is paid off. Converting a conventional loan to a biweekly does not change the interest rate. What it does is to use the extra payment you make every year to reduce the balance, which in turn reduces interest payments. The loan is paid off early, just as it would have been if you had begun with a mortgage carrying a shorter term.
In fact, borrowers taking out a new loan who are attracted to the accelerated repayment schedule on a biweekly, may be better off with a conventional loan having a shorter term. For example, 15 and 20-year loans carry lower rates than 30-year loans, whereas a borrower taking a 30-year biweekly will pay the 30-year rate.
If you already have a 30-year mortgage and are attracted by the prospect of paying it off early, here are some ways you can do it yourself.
Use your bonus. Many people receive bonuses at the end of the year. Adopt the practice of sending your lender an additional check equal to the amount of the bonus, marked "partial prepayment", along with your regular check for the monthly payment. Note: if you make an extra payment equal to your regular monthly payment once every year, you will pay off the balance just as you would with a biweekly.
Increase your monthly payment. Simply increase your current monthly payment by the amount you feel you can comfortably afford. Check with your lender as to whether you should write a separate check for the additional amount.
Note: if you add an amount equal to 1/12 of the payment, you will pay off the loan a little earlier than if you take out a biweekly. You start reducing the balance (and interest on that balance) with the first additional payment, whereas with a biweekly it takes a year before you begin reducing the balance.
For example, on a $100,000 8% loan for 30 years, a biweekly will pay off in 277 months and save $44,160 in interest payments. Adding 1/12 to the payment results in payoff in 275 months and saves $45,901 in interest.
Establish a biweekly deposit account. Start a new account with a bank that has an automatic payment privilege, and arrange for it to make your monthly mortgage payment every month. Then pay half the monthly payment into that account every two weeks. At the end of each year, write a check on this account for an amount equal to one month’s payment and send it to the lender marked "partial prepayment".
All of these approaches require some amount of self-discipline on your part, which you may or may not be able to manage. Having a third party set up the procedure and then legally obligating yourself to make the additional payments forces the discipline upon you. In the last analysis, this discipline is the only service you receive when you purchase a biweekly deal from a third party. Whether you need it only you can decide.
Note: In addition to the biweeklies considered in this article, there are bimonthly mortgages and simple interest biweekly mortgages. See Bimonthly and Biweekly Mortgage Payment Plans.
Biweekly payment plans offered by lenders and third parties impose a savings discipline on borrowers that may be useful, but borrowers who don't need the discipline can roll their plan. They can make extra payments to be applied to principal whenever they receive a bonus or some other windfall. Or they can add a fixed amount every month to their scheduled payment. If they add 1/12 of the payment, they will pay off the loan a little earlier than with a biweekly.
Biweekly Payment Plans Are Not Magic
"A broker suggests that for only $350 I can convert my existing mortgage to a biweekly mortgage that would pay off the loan in 20 years rather than 30 and save $65,000 in interest payments. It looks like magic…Am I missing something?"
I have another deal for you. Pay me $350 and I’ll arrange for you to pay half of your monthly electrical bill every two weeks. At the end of a year, voila!, I will produce a bonus for you equal to an average month’s bill. And I’ll keep generating the bonus year after year. Do we have a deal?
The "magic" in both deals is paying half the monthly payment every 2 weeks, which results in an extra monthly payment every year. (Twenty-six payments, each one for half of one monthly payment, is the equivalent of 13 monthly payments rather than 12). This extra payment is the magic that pays off a biweekly mortgage early, but you need not pay anyone to do the trick for you.
The biweekly mortgage dazzles a lot of people because they confuse the interest payments over the life of the loan with the interest rate. Total interest payments paid over the life of a loan depend on the rate, on the amount borrowed, and on how rapidly the loan is paid off. Converting a conventional loan to a biweekly does not change the interest rate. What it does is to use the extra payment you make every year to reduce the balance, which in turn reduces interest payments. The loan is paid off early, just as it would have been if you had begun with a mortgage carrying a shorter term.
A Shorter-Term Mortgage May Be Better Than a Biweekly
In fact, borrowers taking out a new loan who are attracted to the accelerated repayment schedule on a biweekly, may be better off with a conventional loan having a shorter term. For example, 15 and 20-year loans carry lower rates than 30-year loans, whereas a borrower taking a 30-year biweekly will pay the 30-year rate.
If you already have a 30-year mortgage and are attracted by the prospect of paying it off early, here are some ways you can do it yourself.
Rolling Your Own Extra Payment Program
Use your bonus. Many people receive bonuses at the end of the year. Adopt the practice of sending your lender an additional check equal to the amount of the bonus, marked "partial prepayment", along with your regular check for the monthly payment. Note: if you make an extra payment equal to your regular monthly payment once every year, you will pay off the balance just as you would with a biweekly.
Increase your monthly payment. Simply increase your current monthly payment by the amount you feel you can comfortably afford. Check with your lender as to whether you should write a separate check for the additional amount.
Note: if you add an amount equal to 1/12 of the payment, you will pay off the loan a little earlier than if you take out a biweekly. You start reducing the balance (and interest on that balance) with the first additional payment, whereas with a biweekly it takes a year before you begin reducing the balance.
For example, on a $100,000 8% loan for 30 years, a biweekly will pay off in 277 months and save $44,160 in interest payments. Adding 1/12 to the payment results in payoff in 275 months and saves $45,901 in interest.
Establish a biweekly deposit account. Start a new account with a bank that has an automatic payment privilege, and arrange for it to make your monthly mortgage payment every month. Then pay half the monthly payment into that account every two weeks. At the end of each year, write a check on this account for an amount equal to one month’s payment and send it to the lender marked "partial prepayment".
All of these approaches require some amount of self-discipline on your part, which you may or may not be able to manage. Having a third party set up the procedure and then legally obligating yourself to make the additional payments forces the discipline upon you. In the last analysis, this discipline is the only service you receive when you purchase a biweekly deal from a third party. Whether you need it only you can decide.
Note: In addition to the biweeklies considered in this article, there are bimonthly mortgages and simple interest biweekly mortgages. See Bimonthly and Biweekly Mortgage Payment Plans.
