The following is a guest post by Kyle Chezum of Lender411.com.
It’s a fact—you’ll save money on your mortgage if you make two half-payments every two weeks instead of one payment each month. In most cases, you’ll reduce your mortgage length by five or six years, and depending on your remaining loan balance, this simple switch will save you tens of thousands of dollars in interest.
It works—but you shouldn’t do it. Not by the books, anyway, and not if you really want to save money.
Why It Works: The Math
The math is simple. Say your monthly mortgage payment is $2,000. If you pay that amount each month, you’ll have put $24,000 toward your mortgage by the end of the year. This amount is divided up between interest and principle, with the majority of the money going toward interest. Lenders structure it this way on purpose in order to stretch out the life of your loan—the longer the principle sits there accruing interest, the more money you’ll end up paying to the bank.
If, however, you make a payment of $1,000 every two weeks, you’ll have paid a total of $26,000 toward your mortgage by the end of the year
- There are 52 weeks in a year.
- You’ll make 26 payments—one every other week.
- Your payment amount will be $1,000.
- Altogether, you’ll pay $26,000—the equivalent of 13 full monthly payments.
This extra payment can be used to pay off the principle of the loan directly. As your principle decreases, your loan term shortens. As your loan term shortens, your total interest burden diminishes. You save money.
Think you can’t afford it? Chances are you won’t miss that extra $2,000 per year. Here’s why.
Why It Works: The Psychology
The vast majority of Americans get paid biweekly. Your monthly mortgage payment typically comes out of the combined total of both those paychecks. But switch your perspective. If you take out a smaller mortgage payment from each paycheck, you likely won’t feel much of a difference in your monthly budget—that extra $2,000 payment will be spread over the entire year. It’s like a savings account for your mortgage.
The Downside: Scams and Regulations
Your lender may charge an early repayment penalty if you try to make extra payments. Make sure your mortgage doesn’t have a restriction of this kind. Lenders may not automatically apply your extra $2,000 to the principle of your loan. You’ll have to inform your lender that you want the additional payment put toward the principle rather than the interest. Your lender isn’t going to do this for you.
Lenders don’t like biweekly payments. If you try to organize a formal, automated biweekly payment plan, you’ll likely get the runaround. Numerous third-party intermediaries exist and will negotiate with your bank to arrange such a plan for you, but they’ll charge you anywhere from $250 to $500 dollars to activate the account, and you’ll pay a fee for each transaction. At two transactions a month, you’ll pay a lot of money to this third-party—money that you could have poured directly into your mortgage.
The Solution: Do It Yourself
It seems that actual, legitimate biweekly payment plans aren’t an option unless you want to reduce your potential savings significantly. The solution, of course, is to avoid the third-party interlopers and the banks altogether. Don’t do it by the books. Do it yourself.
- Set up a new savings account, separate from any other accounts you have.
- Deposit half of your mortgage payment into this account every other week. In our example, that’s $1,000 from every paycheck.
- Continue making your monthly payments—your lender won’t know the difference—but pay them from this account.
- At the end of the year, you’ll have an additional $2,000 saved up in this account.
- Use this money to make an extra lump sum mortgage payment at the end of the year.
There—your very own biweekly payment plan, and you don’t have to jump through any hoops or pay any fees to arrange it.
About the author: This guest post was provided by Kyle Chezum, a content specialist at Lender411.com. Lender411.com helps homebuyers compare mortgage rates, find local lenders, and locate the best mortgage packages available.