Bi-weekly Mortgage Plans: Peeking Behind the Curtain
In this modern age of mass mailings and email spam, it’s the rare homeowner who hasn’t received an offer from a bi-weekly mortgage company. These offers tout their ability to help pay off a mortgage faster, saving tens of thousands of dollars in interest. Getting out of debt sooner and saving on interest are both extremely desirable goals we champion each month in the Sound Mind Investing newsletter. So what should be made of these bi-weekly mortgage programs?
In answering that question, it’s crucial to distinguish between the big picture goals being accomplished and the actual detail of how these plans operate. These folks who market these plans aren’t lying when they claim to dramatically cut interest costs and help you retire your loan faster. But they’re trying to pull a fast one on you just the same.
To identify the sleight-of-hand here, we need to step back and examine how bi-weekly mortgage plans work. These plans typically have you commit to paying half of your normal mortgage payment every two weeks. This means you make 26 “half” payments, or the equivalent of 13 “regular” mortgage payments. It’s important to recognize you’re making the equivalent of one extra mortgage payment each year under these plans.
This is where things typically get a bit fuzzy. The plans emphasize the bi-weekly nature of the payments, making it sound as though by paying more often, you’re able to save big on interest costs. What many participants don’t realize is that most of these plans don’t pay more often, and the bi-weekly element of the program is just a smokescreen.
The plans typically take each bi-weekly payment out of your account, and place it in another account. They then pay your regular monthly payments, just as you would without the plan. The extra money that isn’t needed to pay your regular monthly payment sits in the account until there’s enough to make an extra half payment, which the company then does.
In short, all these plans typically do for you is make two extra half-payments per year on your behalf. The rest of the year, it’s just your regular mortgage payment being made each month, despite the supposed bi-weekly nature of the plan. And for this you normally pay a hefty setup charge, plus a per-payment fee on each of the 26 bi-weekly payments taken from your checking account.
To summarize, bi-weekly payment plans do dramatically cut your long-term interest costs and help you pay off your loan faster. But those effects have almost nothing to do with the “bi-weekly” element of the plan. Almost all of the benefit comes from making that one extra payment per year. But these companies know they’d never get you to fork over all the money in fees if they made it obvious that you could save big on your mortgage simply by paying more sooner! So they disguise this simple fact with the bi-weekly emphasis as if it’s the timing that matters. It’s not the timing, it’s the extra principal you’re paying that does all the heavy lifting.
By now, many readers are no-doubt thinking, “Wait a second — if that’s all there is to it, I can do that myself!” Exactly. If you want to get almost the entire benefit promised by a bi-weekly payment plan without all the extra fees, it’s easy to do so. Just take the amount you normally pay in mortgage principal and interest each month, and divide it by 12. Add that amount to your monthly payment, and you’re done. No complicated schedules to follow or annual adjustments to make.
Make no mistake though, this incredibly easy step can indeed save you the huge dollars the bi-weekly marketing letters promise. For example, a 30-year, $150,000 mortgage at 6% requires a monthly payment (principal plus interest) of $899.33. Paid off on a regular 30-year schedule, you’d pay $173,757 in interest alone.
By adding 1/12 extra each month (and rounding up 75 cents to an even dollar figure) and paying $975 each month instead, you’d shave 5½ years off the length of your mortgage while paying $136,652 in total interest. That’s a savings of $37,105 over the life of your loan, just by paying an extra $75 per month!
At this point, the bi-weekly mortgage company would pull out the heavy artillery: “Sure you could do this on your own, but only 3% of homeowners actually pay extra regularly on their mortgage. You’re not that disciplined. How likely are you to be one of the 3%?”
C’mon, it’s easy. We’ve just shown that all you have to do is make one calculation and then simply write a second check to send in with your mortgage payment that has the additional amount. You’re sending a check to your mortgage company anyway — how much more discipline does it take to write two checks instead of one?
If you still don’t quite trust yourself to follow through, rest easy. If you don’t want to rely on your inner strength to write a second check, then don’t. Have your mortgage company or bank automatically schedule the extra amount to be paid each month. That way you never see the extra money, and it’s never a temptation to use it for something else. This is a great way to preserve the flexibility to drop down to your original payment if you ever need to, without it being so easy that you’re actually likely to do it if it’s not an emergency.
I’d be remiss not to point out that if you have other types of debt, you’re almost always better off paying them off first before paying extra on your mortgage. That’s especially true given today’s low mortgage rates. But if you’ve successfully eliminated your other debts and have a healthy emergency fund established, paying a little extra on your mortgage each month is a terrific way to advance financially.
Take a few minutes to play with the “Amortization Schedule Calculator” at http://www.bankrate.com/ (go to the main site and click “Calculators”). It’s a wonderfully captivating tool that let’s you vividly see the impact of adding a little to your monthly mortgage payment. Even if you can’t afford much extra right now, you’ll likely be surprised at the impact of just rounding your payment up to the nearest $50, $25, or even $10 cutoff.
By chipping away like this, you can realize the promise of the bi-weekly mortgage promotions and save thousands of dollars, but without falling for their sleight-of-hand and paying lots of extra fees along the way.
© Sound Mind Investing
Published since 1990, Sound Mind Investing is America's best-selling financial newsletter written from a biblical perspective. 
Originally published May 13, 2009.
