Are bi-weekly mortgage payment plans a scam?

We just refinanced our home :) at a much lower interest and lower length (15 years). Do you recommend third-party administrators to do a bi-weekly payment plan (i.e. 26 pays/year = 13 monthly payments)? Some report this is a scam, but we like the idea of spreading our house payment between the two pay cycles and paying a little extra per year. Thanks so much!

Karen

Hi Karen!

You know, it’s not often I get to congratulate someone on making a great refinancing decision, but you’ve done just that. Congratulations! And then you tell me that you want to pay the thing off with an accelerated payment schedule? Oh, Karen… I’m going to have people emailing me wanting to know if you have a sister who might be available.

However, I’ve heard the same things you have. Are bi-weekly pay plans a scam, or are they a good idea? I mean, how can paying more on your mortgage be a bad thing? Well…

No, that’s not a bad thing. I’m all for paying down your mortgage as quickly and efficiently as possible. Clearly, you are too, based on your actions and question. The problem with the bi-weekly payment plan, however, is two-fold. I’ll warn you now if you haven’t had to shake your head recently, loosen those muscles up.

First, mortgage companies frequently charge people to enroll in a bi-weekly repayment program. Yep. I’m not even joking. Why do they do this? Technically speaking, they have to push a couple of buttons to make the appropriate changes, and that’s oh so hard. More seriously, they are losing out on some interest by switching you to the plan, so they want to make you think twice about it before you jump in. But I said the problem was two-fold…

What does the mortgage company do with your half payment while it waits for the rest? Do they apply it to the remaining principal and appropriate interest? Nah. They sit on it and wait for the rest to come in. Once they have an entire payment (ie two bi-weekly payments), they then apply it to the mortgage and the principal is reduced according to where you are in the repayment schedule. Huh. That doesn’t feel as good, does it?

What ramifications does this have on your mortgage? Well, it’s still not all bad. You end up making one extra payment per year (as you noted), and that can add up fast. By making that extra payment from the beginning of your mortgage you’ll have it cleaned up in just under 13.5 years, saving you a significant amount of interest.

I’m left asking the question, though, “isn’t there a way to do this on our own?” That answer is, absolutely. Plus, it will be slightly more effective than the typical bi-weekly plan. Here’s how it works. Take your mortgage payment and divide it by 12. For this example, we’ll use $1500 as our hypothetical mortgage payment.

$1,500 / 12 = $125

We’ll need to come up with an additional $125 each month to end up equaling that extra payment each year. If we add that on to our normal payment, we get $1,625/month.

$1,500 + $125 = $1,625

From here, you’ve got two options. You could pay that $1,625 each and every month and still get your one extra month in each year. No programs to enroll in, no fees to be paid. You’re dipping your toes into the waters of accelerated mortgage payment nirvana. Just make sure to tell your mortgage company to apply the extra payment to the principal of the loan instead of the next month’s payment.

Or… you could pay the $1,625 on a bi-weekly basis and get an even bigger boost in your repayment efforts. Follow me on this one:

$1,625 / 2 = $812.50 bi-weekly

$812.50 x 26 payments = $21,125 per year

That compares to the standard annual payment of:

$1,500 x 12 = $18,000 per year

If you follow the “super-payoff plan” (I just coined that and I will be filing for copyrights ASAP), you’ll pay an extra:

$21,125 - $18,000 = $3,125 annually

Another way to look at that is, you’re paying an additional 17% of your standard payment towards your mortgage principal each and every year in a relatively painless way.

$3,125 / $18,000 = 17.3%

“Sure,” you say. “But that’s because I’m paying more each month.” Yes, you’re absolutely paying more towards your mortgage every month, but that’s kind of the point, isn’t it? There isn’t a magic repayment schedule that we can elect that will save us a mountain of interest dollars. It’s just math, plain and simple. The more we pay towards the principal each month, the less we will be charged with interest. You’ll need to decide how much you can afford to budget each month, and once that’s set, it doesn’t matter too much how you do it. Monthly or bi-weekly, whatever. If you can be aggressively paying down your mortgage, you’ll be happy with the results no matter how you decide to go about it.