by Michael J. Applegate, President and Founder of TimeValue Software.
Over the years I have heard about how much money you can save by switching from monthly mortgage payments to bi-weekly payments.
The concept of a bi-weekly mortgage is to make half of your monthly payment every two weeks. For example, on a 15 year $200,000 loan, rather than paying $1,911.30 once a month, you would make a $955.65 payment ($1,911.30 divided by 2) every two weeks. With this payment adjustment you can shorten the term of the loan by approximately 26 months and save thousands of dollars of interest in the process.
On the surface it appears the big savings resulting from bi-weekly payments come from making your payments earlier. This is not true. The real savings comes from making the equivalent of one extra monthly payment each year. Let me illustrate. Using simple interest with a 360 day year, assume the following facts:
Loan Amount $200,000 $200,000
Date of loan 1/1/2005 1/1/2005
Interest rate 8% 8%
Payment amt $1,911.30 $955.65
Pmt period monthly bi-weekly
First pmt date 2/1/2005 1/15/2005
No. of pmts 180 336
Last pmt date 1/1/2020 12/2/2017
Total pmts $344,035 $321,225
Total interest $144,035 $121,225
The attention grabber for most of us is the $22,810 saved over the term of the loan ($344,035 – $321,225). In addition, most people like that the loan is paid off 26 months earlier. But let’s take a closer look at the difference between making monthly and bi-weekly payments.
If you make 12 monthly payments, you will end up paying $22,936 ($1,911.30 x 12) in one year. If you make bi-weekly payments, you will make 26 payments in one year totaling $24,847 ($955.65 x 26). The difference of $1,911 results from the extra full payment made each year under the bi-weekly schedule. If you look at a calendar and count the number of two week periods in a month, you will find that twice each year you will make three bi-weekly payments in a month. For 2005 the extra payments will fall in July and December. Now, this may work out fine if you get paid every two weeks.
But what if you get paid twice a month? With bi-weekly payments you should be aware of the cash requirements so you don’t get caught without enough cash to make your payments. Why not increase the amount of your monthly payment by a constant amount?
Suppose you take the extra annual payment made with bi-weekly payments and spread it out over 12 months. Your new monthly payment would be $2,070.59. If you make this new monthly payment, your loan will be paid off in 156 months. Total payments over the term of the loan will be $321,800.
How does this compare with bi-weekly payments? With bi-weekly payments your total payments are $321,225, lower by $575 than the total payments made by spreading the extra payment over 12 months. You end up paying an extra $575 over a 13 year period.
Is it worth the $575 savings to make 26 payments each year instead of 12? Consider that over a 13 year period you will write 336 checks instead of 156. That works out to 180 more checks. Just think of the time it takes for you and the mortgage company to handle the increased volume. This is why most lenders do not like bi-weekly mortgages. Many will do them for you for an additional up-front fee. Why not increase your monthly payment? Get the benefits of a bi-weekly loan without the additional expense.
Michael J. Applegate is President and Founder of TimeValue Software.