Is Bi-Monthly Really Better?
October 4, 2008 9:17 PM Subscribe
Is it really that much better to pay off a mortgage in bi-monthly payments rather than once-a-month payments?
TAKE *YEARS* OFF YOUR MORTGAGE!!! In the past, I've gotten letters from my mortgage company, telling me that I can shorten the length of my loan by X number of years and pay Y thousand dollars less if I just pay them in two smaller monthly payments, rather than one large one.
Of course, the first red flag is that my mortgage company itself is the one doing this.
Are there advantages to this? Disadvantages? Aside from having that money in my checking account for two extra weeks? I mean, heck, I'm not going to do anything with it in those two weeks anyway...
Let's hear it!
TAKE *YEARS* OFF YOUR MORTGAGE!!! In the past, I've gotten letters from my mortgage company, telling me that I can shorten the length of my loan by X number of years and pay Y thousand dollars less if I just pay them in two smaller monthly payments, rather than one large one.
Of course, the first red flag is that my mortgage company itself is the one doing this.
Are there advantages to this? Disadvantages? Aside from having that money in my checking account for two extra weeks? I mean, heck, I'm not going to do anything with it in those two weeks anyway...
Let's hear it!
Of course, the first red flag is that my mortgage company itself is the one doing this.
Honestly, I'd believe someone that already has my money over someone who's looking to get it.
The actual gist is that you've broken it down wrong. Making a half-payment every two weeks versus making one once a month gets you making an extra payment every year (26 half payments) instead of 12 full payments (24 half payments) just because of calendar irregularities. And that extra payment is generally applied directly to principle. So your bank is absolutely correct. If you can swing it financially, this is a sound idea.
posted by Mayor Curley at 9:36 PM on October 4, 2008
Honestly, I'd believe someone that already has my money over someone who's looking to get it.
The actual gist is that you've broken it down wrong. Making a half-payment every two weeks versus making one once a month gets you making an extra payment every year (26 half payments) instead of 12 full payments (24 half payments) just because of calendar irregularities. And that extra payment is generally applied directly to principle. So your bank is absolutely correct. If you can swing it financially, this is a sound idea.
posted by Mayor Curley at 9:36 PM on October 4, 2008
You are not just paying more frequently, you're paying more over a year's time. If your monthly mortgage payment is $1000, that's $12,000 a year. If you switch to $500 every 2 weeks, that's 26 payments of $500, or $13,000.
You can also choose to pay slightly more every two weeks, to pay down the house even faster, but given the shaky economy, you may not want to commit to higher regular payments. But if you have the money to spare for that slightly higher payment now right now, sock it away in a high interest savings account at ING or HSBC, get some interest, and apply it as a lump payment as often as your bank permits.
posted by maudlin at 9:36 PM on October 4, 2008
You can also choose to pay slightly more every two weeks, to pay down the house even faster, but given the shaky economy, you may not want to commit to higher regular payments. But if you have the money to spare for that slightly higher payment now right now, sock it away in a high interest savings account at ING or HSBC, get some interest, and apply it as a lump payment as often as your bank permits.
posted by maudlin at 9:36 PM on October 4, 2008
You could also put aside $50 (or whatever) every two weeks and simply make a lump-sum payment at the end of the year. Personally, I like to synchronize my mortgage payments with my paycheque so if you're net getting paid bi-weekly I wouldn't do it as it would tend to mess up your cash flow twice a year.
posted by GuyZero at 9:44 PM on October 4, 2008
posted by GuyZero at 9:44 PM on October 4, 2008
Like others said, you can accomplish the exact same thing by making one extra principal-only payment every year.
posted by AaRdVarK at 11:41 PM on October 4, 2008
posted by AaRdVarK at 11:41 PM on October 4, 2008
^ wut they said. But it helps to underline that every dollar you pay today is one less dollar getting dinged with interest for the life of the loan.
Over a 30 year loan with a 4% net interest rate (accounting for tax bennies), that's a $3 interest savings.
Also, paying earlier in the billing cycle does give you a bit of a credit. On a $2000 principal payment and two weeks pre-payment, that works out to around $5/mo, which by the magic of the above accelerated payment is also worth around $15/mo in actual principal reduction, $180/yr.
posted by troy at 12:22 AM on October 5, 2008
Over a 30 year loan with a 4% net interest rate (accounting for tax bennies), that's a $3 interest savings.
Also, paying earlier in the billing cycle does give you a bit of a credit. On a $2000 principal payment and two weeks pre-payment, that works out to around $5/mo, which by the magic of the above accelerated payment is also worth around $15/mo in actual principal reduction, $180/yr.
posted by troy at 12:22 AM on October 5, 2008
Here's a good calculator that shows the financial benefits of bi-weekly. We do the bi-weekly plan, we are projected to save about $30K on our total mortgage payments and pay it off about 6 years early.
posted by pokeedog at 8:34 AM on October 5, 2008
posted by pokeedog at 8:34 AM on October 5, 2008
I would like to point out that those letters 'TAKE *YEARS* OFF YOUR MORTGAGE!!!' generally are trying to get you to sign up for a 'plan' to do this--there is no need to pay to particiipate in this plan, just make the payments on the biweekly schedule instead of monthly and you get the same result without paying for it.
posted by lemonade at 10:31 AM on October 5, 2008
posted by lemonade at 10:31 AM on October 5, 2008
You should think of this as part of your overall investment strategy. Your house is probably the largest asset you own. The more money you put into your house, the less you have available for other investments (such as stocks). Also consider that the interest rate available to you on a house is lower than what you can get almost anywhere else because of the mortgage interest deduction. If you expect to get a better return in the stock market than the effective (after-tax-deduction) interest rate on your house, then you'd be better off putting the money in the stock market. If you're investing over a long enough time horizon (and the current financial clusterfuck is not the end of the world as we know it), you can expect 10% returns from the US market as a whole. $100 you put in the market today will be worth $672 in 2028. If you have an interest rate of 7% on your mortgage, the effective interest rate will be somewhat lower after the interest tax deduction (how much lower depends on your income, but 5% would be a conservative guess). By putting that $100 in the stock market, you're borrowing at 5% to invest at 10%.
This changes if your house is worth less than your mortgage, if you have a shorter-than-20-years time horizon for retirement, or if America is about to be burned to the ground like ancient Rome.
Also, if you have a variable rate mortgage and you think that inflation is fixing to be a problem, you might prefer to pay off the mortgage faster since interest rates may skyrocket in that case.
posted by bananafish at 2:56 PM on October 5, 2008
This changes if your house is worth less than your mortgage, if you have a shorter-than-20-years time horizon for retirement, or if America is about to be burned to the ground like ancient Rome.
Also, if you have a variable rate mortgage and you think that inflation is fixing to be a problem, you might prefer to pay off the mortgage faster since interest rates may skyrocket in that case.
posted by bananafish at 2:56 PM on October 5, 2008
Yeah, I was going to say what bananafish said: Don't overlook the opportunity cost of the other investments you could be putting that money into. Typically, you would want to make sure that you fully fund your retirement accounts before using any leftover cash to prepay your mortgage.
But also, as our own jdroth likes to point out, financial decisions are rarely devoid of emotion -- if you have weighed all the pros+cons, and pre-paying your mortgage helps you sleep better than investing that money in an index fund, then it may be the right thing for you to do (so long as you truly understand the trade-offs you are making)
posted by misterbrandt at 5:27 PM on October 5, 2008
But also, as our own jdroth likes to point out, financial decisions are rarely devoid of emotion -- if you have weighed all the pros+cons, and pre-paying your mortgage helps you sleep better than investing that money in an index fund, then it may be the right thing for you to do (so long as you truly understand the trade-offs you are making)
posted by misterbrandt at 5:27 PM on October 5, 2008
If you have an interest rate of 7% on your mortgage, the effective interest rate will be somewhat lower after the interest tax deduction (how much lower depends on your income, but 5% would be a conservative guess). By putting that $100 in the stock market, you're borrowing at 5% to invest at 10%.
Two problems with this analysis. First, you can't compare a pre-tax return to an after-tax return. Your 5% number is after tax deductions. Your 10% return is pre-tax. The easiest way, though not necessarily most accurate, is to compare both pre-tax numbers, so it would be 7% vs. 10%.
But the second problem is that these two alternatives are not of equal risk. Paying your mortgage early is a guaranteed, riskless return of 7% (pre-tax). The 10% return is much higher risk. You need to compare to an investment of equivalent risk which would be long term treasury bonds which are only yielding about 3.9%. Clearly, paying off the mortgage is a better investment.
But as others have pointed out, there are other considerations, the primary being liquidity. You should pay off the mortgage early only if you already have an emergency fund so that you are not strapped for cash. You should also contribute to your tax deferred accounts first.
posted by JackFlash at 6:48 PM on October 5, 2008
Two problems with this analysis. First, you can't compare a pre-tax return to an after-tax return. Your 5% number is after tax deductions. Your 10% return is pre-tax. The easiest way, though not necessarily most accurate, is to compare both pre-tax numbers, so it would be 7% vs. 10%.
But the second problem is that these two alternatives are not of equal risk. Paying your mortgage early is a guaranteed, riskless return of 7% (pre-tax). The 10% return is much higher risk. You need to compare to an investment of equivalent risk which would be long term treasury bonds which are only yielding about 3.9%. Clearly, paying off the mortgage is a better investment.
But as others have pointed out, there are other considerations, the primary being liquidity. You should pay off the mortgage early only if you already have an emergency fund so that you are not strapped for cash. You should also contribute to your tax deferred accounts first.
posted by JackFlash at 6:48 PM on October 5, 2008
If you have a 401k that offers employer matching, for example, you're getting an instant 100% ROR per JackFlash's suggestion. Unless you're maxing your 401k, prepaying your mortgage may be less useful especially considering the tax-deductibility of US mortgages (in Canada where interest is not deductible against income and there is no employer matching of retirement savings, prepaying mortgage interest is more advantageous)
posted by GuyZero at 7:05 PM on October 5, 2008
posted by GuyZero at 7:05 PM on October 5, 2008
seconding lemonade: the most likely reason your mortgage company is making this offer is that they can charge you to set up the payment schedule. They're not doing it as charity.
I believe you can generally make payments on any schedule you wish, but sometimes the fine print of the loan terms may prohibit certain kinds of off-schedule payments, or may only apply payments once per month, or may charge a fee for early payment. It's all in the contract, so read it carefully.
posted by Chris4d at 5:53 PM on October 6, 2008
I believe you can generally make payments on any schedule you wish, but sometimes the fine print of the loan terms may prohibit certain kinds of off-schedule payments, or may only apply payments once per month, or may charge a fee for early payment. It's all in the contract, so read it carefully.
posted by Chris4d at 5:53 PM on October 6, 2008
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posted by amyms at 9:25 PM on October 4, 2008