February 29, 2016
For many borrowers, it is easier to accelerate the pay down
of a mortgage balance if the process of making extra
payments is routinized. Then the extra payments become a
habit. The questions posed below apply to plans of this
sort.
Q: What is a biweekly mortgage and
how does it work?
A:
A biweekly mortgage is one on which the borrower makes a
payment equal to half the fully amortizing monthly payment
every two weeks. Since there are 26 biweekly periods
in a year, the biweekly produces the equivalent of one extra
monthly payment every year. This results in a significant
shortening of the period to payoff. For example, a 4%
30-year loan converted to a biweekly pays off in 310 months
– or 25 years, 10 months.
Q: For whom does a biweekly make sense?
A: It makes sense for borrowers who have the capacity to pay more than required but need the discipline of a well-defined routine.
Q: Do all lenders offer a biweekly option?
A:
No, and some of those that do charge for it. But you can
always create your own. Open a bank account into which you
deposit half the payment every two weeks, and withdraw the
full monthly payment every month for submission to the
lender. At the end of a year, there will be enough in
the account for a double payment.
Q: Are there any approaches that don’t require a special
bank account?
A:
Yes, the simplest is to increase the scheduled monthly
payment by 1/12. If the payment is $1200, for example, you
remit $1300. Doing it this way will actually pay off the
loan a little sooner than using a biweekly because the loan
balance begins to decline with the first payment rather than
after a year.
Q: What is a bimonthly mortgage?
A:
A bimonthly mortgage
is one on which the borrower makes half the fully amortizing
monthly payment
on the 15th
of the month, and the other half on the first of the month.
In contrast to the biweekly, there are no extra payments,
but payments are credited twice a month rather than once a
month. That is the only source of benefit to the borrower,
and it is small. On
30-year mortgages with rates of 6% or less, payoff occurs
after 719 half payments, shaving just one-half of a month
off the term.
Q: For whom does a bimonthly make sense?
A:
It may make sense for any borrower who finds that making
payments twice a month is convenient,
and
whose lender offers the option at no cost. You cannot roll
your own bimonthly, because it is wholly dependent on the
willingness and ability of the lender to credit payments
twice a month.
Q: Is there
any way to add extra payments to a bimonthly?
A:
Yes, borrowers who are using a bimonthly can add to their
payments in any way they like, and I have developed a
spreadsheet that is designed to help them, see
Extra
Payments on Bimonthly Payment Fixed-Rate Mortgages.
It
allows you to assess the impact of additional bimonthly
payments on your payoff period. For example, the borrower
with a $200,000 mortgage at 4% who pays $477.42 twice a
month gets to a zero balance just half a month early without
extra payments. But if the borrower rounds off the payment
to $500, payoff occurs after 659 payments, or 30.5 months
early.
Q: What is a weekly payment mortgage?
A: A weekly payment mortgage is
one on which the fully amortizing monthly payment is
multiplied by 12 and divided by 52 to get the payment made
every week. There are no extra payments and the weekly
payments are credited to the borrower’s account only once a
month. The weekly payment does not result in an early payoff
unless the borrower makes extra payments. The lender may
charge for offering the facility.
Q: For whom does a weekly payment mortgage make sense?
A:
The only borrowers who might
benefit are those who are paid weekly and place a high value
on the budgetary discipline imposed by having to pay their
mortgage weekly.
Q: Is it true that the payoff
period of a mortgage can be cut in half if the borrower
doubles the principal payment each month?
A:
Yes, it is true, but there is an important proviso. The
extra payments required are larger than the principal
payments that are customarily displayed as part of an
amortization table, because such tables assume that there
are no extra payments. For the scheme to work, the extra
payment in each month must match the actual principal
payment in that month, which amount has been affected by
prior extra payments. This means that the required extra
payment has to be recalculated every month.
Q: For whom does a doubling-of-principal scheme make sense?
A: It makes sense for a nerd with rising income. You have to
be something of a nerd to appreciate having to recalculate
the required extra payment every month. And you also must
have the capacity to raise the ante every month. For
example, in using this technique to pay off a 30-year 4%
mortgage of $280,000 in 15 years, the required extra payment
would rise from $403 in month 1 to $597 in month 60, to $889
in month 120, to $1325 in month 180.
Q: How would the mortgage professor accelerate the payoff of
his mortgage?
A:
He would develop an extra payments plan using a special
calculator he and Chuck Freedenberg designed specifically
for this purpose. The calculator provides maximum
flexibility in defining extra payment intervals, amounts,
and durations, and it shows the payoff period for any
combination of these factors. With this calculator, I can
design a program that is geared exactly to my own unique
needs, and monitor the progress from month to month. See (Mortgage
Payoff Calculator 2a).
