Bi-weekly Mortgage Payments

I had an email from Jen last week about a deal her bank was offering where, for a small set-up fee, they would switch her mortgage payments from monthly payment to bi-weekly payments, or payments every two weeks, of half the current monthly amount. She suggested I expound on this phenomenon and whether or not it's a good idea.

I'll start with the answer -- yes and no.

First the no: Paying anybody extra, for any reason, to take your money is just foolishness.  They're already taking your money; why would you pay them more to take it?  It's for this reason I have my water bill deducted from my checking account and not paid with credit card -- the water company would charge me a monthly convenience fee to use the card, but not the checking account.  I also pay my auto insurance in semi-annual installments, because if I paid monthly, they'd charge me an extra couple bucks a month. 

I also adamantly refuse to pay my federal taxes by credit card because they charge some extortionate rate to do so.  I send them a check -- they still get the money they're owed, and not a penny more.

Now, the yes: Paying half your regular payment every two weeks is a great way to get yourself debt free faster, but it's simply a trick.  Like all good tricks, however, it works, and here's why:

Say my monthly payment is $1,000.  In a year, I'll pay $12,000.

Now, if I pay half that amount every two weeks, I'll pay $500, but I won't pay that 24 times, because there aren't 48 weeks in a year -- there are 52.  I'll pay that $500 a total of 26 times, so I'll pay $13,000 for the year.

Big whoop, you say.  So what.  Well, here's the "whoop" -- on a regular 30-year loan, the bi-weekly payments (that extra $1000 a year) will have it paid off about 4 years early, and will save you 15%-20% in interest over the life of the loan. 

Bi-weekly payments are also nice because most of us get paid bi-weekly, which means it's easy for us to just assume a set part of every paycheck is our mortgage payment.  This actually makes budgeting easier in the long run, though it can take a little bit to get used to it.

But the answer, my friends, isn't bi-weekly payments; as I said, that's just a trick.  The real answer is Extra Principal Payments (EPP).  The beauty of EPP is you can make them in any amount, at any time.  Check with your mortgage company to see how they need to be notified of extra principal payments (including making bi-weekly payments on your own without their help), but for most of them, simply putting "apply extra payment to principal" is enough to have them do so, instead of taking the money and holding it back as part of your next regular monthly payment.  Others may have different requirements, so check with your lender.

The reason this works is your interest -- the part of the money you pay for the privilege of using the bank's money -- is calculated directly on your principal.  The less principal you have, the less interest you pay.  Since your regular monthly payment pays off all the interest you owe before it ever gets rid of a cent of your principal, the only way to get rid of the loan faster is by making EPP.

 "But Jason," I hear you saying, "don't I need to put Large Gargantuan Amounts toward the principal to make a difference?"

And you hear me saying, "No."  Let's assume a $150,000, 30-year mortgage at 4.5% interest (not hard to get these days).  Just $10 extra in principal a month pays the loan off 9 months early  -- give up the Adult Beverage of your choice one dinner out a month and you're almost there. 

$50 extra a month pays it off 3 years and 7 months early.  $100 extra, and it's 6 years and 3 months.  For the example above, that means you're paying $860 a month instead of $760.  Not a small thing, but not the end of the world, either.

If you want the bi-weekly payment effect without the hassle, take your monthly payment amount (don't include the escrow amount in this unless you want to -- escrow's a whole different ball of wax ... gross) and divide it by 12.  Make that your monthly EPP, and you'll get close to the same effect as making bi-weekly payments.

Whether you switch to bi-weekly payments (being darned sure not to pay anyone for the privilege of taking your money) or just make extra principal payments in any amount, you're cutting the life of your loan, and saving yourself hundreds or thousands in interest you won't pay. 

If you want to run your own calculations, check out the Mortgage Calculator and the Biweekly Mortgage Calculator from Bankrate.com.