On the Clark Howard Show a couple of years ago, a listener called in to ask if a biweekly mortgage plan (a program where you make half your mortgage payment every two weeks rather than once per month) was a good idea. I was shocked when Clark emphatically told the caller that no, the biweekly mortgage plan was never a good idea.
I was shocked because the biweekly mortgage plan just seems to make sense. If you pay half your payment two weeks early, shouldn’t that reduce some of your principal faster, which should in turn reduce the amount of interest you pay over the life of the loan?
Did Clark’s advice stink? I decided I needed to figure out once and for all if the biweekly mortgage plan was a good idea.
The biweekly mortgage plan doesn’t work like it should work
When I started researching, the first thing I found out was the biweekly mortgage weekly plan doesn’t work like I thought it did. I had assumed when you made your payment every two weeks, that part of the payment would go to interest and part would go to principal. Half your monthly principal payment reducing principal by two weeks out of every month over time would mean a lot less principal. On my $160,000 thirty-year mortgage, it would reduce the amount of time it would take me to pay off the loan from thirty years down to a little over twenty six, while reducing the total amount of interest I would pay by over $14,000.
Sadly, thats not how it works. In reality, when a mortgage company takes your biweekly payment, they don’t apply it to principal, as you might expect. In fact, they don’t do anything with it. They just hold on to it for two weeks until they receive the second half of your payment and apply it to your loan only after they receive the full monthly payment amount. That really takes all the fun out of making your payment early.
There are often fees involved
While there are some mortgage companies out there offering biweekly mortgage payment plans, most do not. If yours does not, there are third parties that will help you set it up, but they charge a fee. You are already paying plenty of fees on your mortgage, and don’t need to pay any extra ones. If you want to pay your mortgage off early, paying extra fees is not the way to get it done.
The real advantage to the biweekly mortgage plan
The biweekly mortgage plan isn’t pure evil, though. There is still one big advantage to it. While many people think of a month as being four weeks, and half a month being two weeks, that isn’t quite true. Because there are 52 weeks in a year, there are 26 biweekly periods. So if you make 26 half payments, that is the same as making 13 regular monthly payments, or 1 extra payment per year. As it turns out, that one extra payment per year can add up — big time.
Once more, I ran the numbers on my 30-year $160,000 mortgage and found that making an extra payment just once per year meant I could pay my mortgage off almost four years faster, in a little over 26 years. This would also reduce my total interest payments over the life of my mortgage by almost $14,000. That isn’t bad.
You don’t need the biweekly mortgage plan
So Clark was right, biweekly mortgage payments aren’t the best idea, but making extra payments turns out to be a pretty good idea. If you have trouble saving up a large enough amount of money to make a full payment, why not make your own program?
You could set up a new savings account, and figure out how much you need to save every month by dividing your mortgage payment by 12. Then, every month you deposit that amount of money into your savings account. At the end of 12 months you would have enough to make that extra payment. You would also get whatever interest your savings account earns, which won’t be much, but will be better than letting your mortgage company hold onto your money for 2 weeks interest free.
About the author: Andy Prescott is a CPA who writes semiweekly articles that are always interesting at artofbeingcheap.com.