Finance Globe

U.S. financial and economic topics from several finance writers.
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Biweekly Mortgage Program? There's a Better Way

If you have a mortgage, you may have received a letter from a company offering to "help" you pay your home off faster by enrolling you in a bi-weekly mortgage program. Their pitch may sound very convincing and probably seems to make a lot of sense.

Here's how it works: On the traditional payment schedule you make one payment a month, equalling twelve payments a year. On the bi-weekly schedule, you make a half payment every two weeks. Since there are fifty-two weeks in a year, this will amount to twenty-six half payments, the equivalent of thirteen full payments a year.

The company that provides the bi-weekly payment service is just a middleman who collects your money every two weeks, puts the money in a trust or escrow account, and then sends the full monthly payment to the mortgage company when the payment is due.

Okay, so in essence, you are simply making one extra full payment per year. Paying any additional to the principal of your mortgage will indeed pay your mortgage off more quickly. But why do you need the bi-weekly mortgage program? You don't.

First of all, there's a catch that comes with that bi-weekly mortgage program. There are actually a few catches:
  • There is typically an "enrollment fee" of about $300 to $400 to start.
  • There is typically a "monthly service fee" of several dollars per payment.
  • There may be an "account maintenance fee" with some programs.
  • You could pay your mortgage down faster, without the involvement of a third party, for free.
  • You lose flexibility in your budget by committing to a payment every two weeks.
Let's put aside the cost of participating in one of these bi-weekly mortgage programs; we can already see that it costs money out of your pocket. When we have to pay to save money, that's typically a red flag to alert us that there's usually a better way.

We'll look at that better way in a moment. But first, consider this:
Prepaying a mortgage is a last priority. Sure, it would be great to have your home paid off five or ten years sooner; owning a home free-and-clear must be a feeling of true freedom. But the interest rate is typically very low compared to other debts you may have. Plus the interest is tax-deductible, making the mortgage's true cost even lower.

There are other, more important things to worry about first: paying off credit cards and other loans, taking care of medical expenses, investing for your retirement, and funding your kids' college tuition.

And keep in mind that it just costs more to live some months than others. Heating bills are higher in winter, cooling bills are higher in summer, gift-giving eats into your budget around the holidays, and extra money gets spent on vacations when the kids are out of school.

Keep flexibility in your mortgage prepayment schedule. You can keep better control of your budget if you allow yourself to send more to principal when you can afford to, and send less when you have a higher-expense month. Or, send no extra to principal whenever your expenses got the best of you and you have to carry a credit card balance for a month or so.

By prepaying your mortgage yourself rather than enrolling in a costly program, you can make the choice to send $500 extra when you get a bonus from work or no extra when your hours get cut. Rather than committing yourself to a program that requires a higher mortgage payment than your own mortgage lender requires, keep in charge of your own mortgage payments.

Now, let's look at some easy suggestions on relatively painless ways to prepay your mortgage on your own:
Pay the equivalent of one extra payment a year. Divide one month's payment by twelve, to represent each month's extra payment under the bi-weekly mortgage program. Then add that amount to each month's payment. For example, say you have a $1200 monthly mortgage payment. Divide by twelve to get $100 extra to your mortgage each month for a total of $1300 a month. It's just a different way of doing the same thing.

Round up to the nearest hundred when writing your check or setting up online bill pay. If your mortgage payment is $725 a month, pay $800 instead. Or, round up to the next hundred, so that you always pay an extra hundred plus. Maybe your mortgage is $880 a month and $20 is just not enough extra for your tastes; make that payment for an even $1000.

Take whatever is left over from last month's budget and add it to the next mortgage payment. If you were able to do really well at keeping expenses down in one particular month, you may have a big chunk to send to principal. In months that were tough on your budget, pay a smaller additional amount or none at all.

Things to consider if you prepay your mortgage:
Be sure that your mortgage doesn't have a prepayment penalty. Most mortgages don't. But if they do, they usually specify that the mortgage can't be paid off before a certain amount of time without penalty, but you won't be penalized for each time you make an extra payment.

So even with a prepayment penalty mortgage, you may be able to knock down your mortgage faster without penalty, as long as it's not paid in full before the specified time period. Even so, if you won the lottery, it still may be better to pay off the mortgage, pay the penalty, and save the many years' worth of interest. You'd just have to do the math to figure it out if it ever came to that.

Be sure that extra amount actually goes to principal and not to escrow or something else. If you write a check, specify on the check that the extra is to go to principal. But if you pay your bills online, fear not. Usually, mortgage companies know to automatically allot your extra payment to principal as long as you already have enough in escrow for taxes, insurance, and other charges.

Some mortgage companies send a monthly mortgage statement (looks very similar to a credit card statement) which shows your last month's payment, additional payment to principal, your principal balance, and your escrow balance. It's easy to verify that your extra payment is going to the right place if your lucky enough to have a mortgage company that sends these mortgage statements every month.

But if your mortgage company sends you an old-fashioned payment coupon book, you don't get the reassurance of seeing, on paper, your principal shrinking each month. Call the mortgage lender's office to talk to someone and find out if your extra payments will automatically go to principal without you specifying for it to, or if you need to actually break out the checkbook for your extra principal payment just so you can put those instructions on each check.

And one more thing to think about while you're trying to pay down your mortgage faster: pay it by the due date. Many mortgages work something like "due on the 1st, but not considered late until the 15th." Not considered late means they won't charge you a late fee, and they will report it to the credit bureaus as being a timely payment.

But the extra you send may not reduce the principal until the following month unless they recieve the payment by the due date, the 1st. I was surprised to find this out when I talked to my mortgage lender a couple years ago. If this is the case with your lender, it may be worth juggling your bill payment schedule so you can make that extra payment early enough to count for the month you send it - after 30 years of payments it will surely make a big difference.
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Monday, 14 October 2019

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