With mortgage rates low, "bi-weekly" mortgages are advertised as a cheaper way to own your home faster. But do bi-weekly and other "extra payment" mortgage programs work?
Is it worth it to sign up for a program committing you to one extra payment per year on your mortgage? Or, is it cheaper to refinance into a loan with low costs?
Understanding your options is the first way to make sure you're making a good choice. Read more about bi-weekly mortgages below.
The typical mortgage asks for one payment per month, which equals 12 payments per year. With a 30-year fixed rate mortgage, therefore, 360 payments are required to pay the loan in full.
Each mortgage payment is split into two parts -- a principal portion and an interest portion. The principal portion is applied to the amount that you owe the bank. This diminishes your remaining loan balance. The interest portion is your cost for borrowing from the bank.
As your loan moves toward maturity, the balance between your mortgage payments' principal-and-interest shifts. In the early years, a significant portion of your payment is comprised of interest and just a small part goes to paying down your balance. It's not until later in your loan's lifecycle does the principal portion of the payment start to grow.
This repayment schedule is the reason why after 5 years or so, your loan's balance has been barely paid down. The technical term for this repayment schedule is amortization (ah-mor-ti-ZHAY-shun).
A bi-weekly mortgage payment program is meant to short-circuit your loan's amortization schedule. Instead of taking 12 payments per year, the bi-weekly payment plan asks for one payment every two weeks, which adds up to 13 payments per year.
Except that you can't make 13 payments per year on your mortgage -- that's not how a mortgage works.
With a mortgage, you pay a certain amount of interest on an annual basis and that amount is covered in your first twelve payments. The 13th payment has to go somewhere, though, so it gets applied to your principal balance; the amount that you still owe to the bank.
And, this is how a bi-weekly payment plan works. With each "13th payment", your loan balance is reduced by the entire amount of the payment. You reach your loan's payoff date sooner.
At today's mortgage rates, bi-weekly payments shorten your loan term by 4 years.
Bi-weekly payments plans work; there's no doubt about that. It's just basic math. However, there are several reasons why homeowners may want to avoid enrolling in a bi-weekly mortgage payment plan.
The first -- and most obvious -- reason to avoid bi-weekly mortgage payment programs is that homeowners choosing to self-manage their bi-weekly payments get better results than via a bank-managed bi-weekly payment program.
Here's how to self-manage : Rather than sending payments to the bank every other week, achieve the same result by making your regular mortgage payment once monthly, and adding 1/12 of your regular mortgage payment to your check.
For every $1,200 in your mortgage payment, in other words, add $100 to your monthly payment.
By sending $1,300 to your lender monthly, you will "overpay" your mortgage by $1,200 annually, which is a 13th payment.
Assuming a $300,000 mortgage at 4.000%, look at how the math works :
This math works because banks don't apply that 13th payment until the year is complete. By contrast, your self-managed system applies 12 times per year.
This may be enough "math" for you to believe it's better to send extra principal with your payment as opposed to doing a bi-weekly plan.
In case it's not, though, remember that agreeing to bi-weekly payments with your lender is contract and, once that contracts starts, you're obligated to make those 13 payments per year no matter what.
By contrast, when you choose to just send extra principal with your payment each month, you avoid a new financial obligation. For example, if it's the holiday season and you'd like "skip a month" of extra payments, you can do it.
Then, sometime later, you can choose to double-up on extra principal to get back on track. It's your choice -- not the bank's.
And, if you're still not convinced that bi-weekly programs are wasteful or risky, double-check whether your lender charges a fee to participate in its 13-payments-per-year program. Some banks do, and that's money wasted.
If your bank is charging for its bi-weekly mortgage payment program, just say "no".
Bi-weekly mortgages aren't typically worth the cost or commitment. Thankfully, though, with current mortgage rates low, the best alternative to a bi-weekly mortgage plan may be to refinance into a new home loan completely.
Taking a refinance to lower rates and putting your monthly savings back into your mortgage as "extra payments" each month accelerates your loan payoff faster than a bi-weekly program ever could.
Assuming a one percentage point drop in your mortgage rate, refinancing your loan and putting the savings back into your loan can shorten your loan's term 63% more than any bi-weekly program.
The speed of payoff is even faster with a zero-closing cost refinance.
A zero-closing cost refinance is a refinance for which all closing costs are paid by your lender in exchange for the homeowner willfully accepting a slightly higher mortgage rate.
In general, a $250,000 refinance can be converted to a zero-closing cost refinance for a 12.5 basis point (0.125%) increase to your mortgage rate.
With today's mortgage rates low, a bi-weekly mortgage program may appear to be a smart way to save money on your loan. However, there are two better ways to own your home quicker -- make extra payments on your own, and re-apply your monthly savings on a refinance.
Take a look at today's mortgage rates now. Quotes are available online at no cost, with no obligation to proceed, and with no social security number required to get started.
The information contained on The Mortgage Reports website is for informational purposes only and is not an advertisement for products offered by Full Beaker. The views and opinions expressed herein are those of the author and do not reflect the policy or position of Full Beaker, its officers, parent, or affiliates.
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