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The Bi-Weekly Mortgage - Who Needs It?
Have you
received an advertisement offering to save you thousands of dollars on
your thirty-year mortgage and cut years off your payments? With email "spam"
becoming more pervasive as everyone tries to "get rich quick" on the
internet, these ads are popping up with troublesome regularity.
The ads promote the "Bi-Weekly Mortgage" and for the most part, do not
come from a mortgage lender. Exclamation points punctuate practically
every claim:
To achieve these wonderful savings all you have to do is allow half of
your mortgage payment to be deducted from your checking account every
two weeks. It's easy. Of course, there is a small "set-up fee" and
usually a "transaction fee" with every automatic deduction.
Essentially, the ads are truthful in almost every respect.
They just want to charge you money for something you can do on your own
for free.
The Basics:
Normally, you make twelve mortgage payments a year. Since there are
fifty-two weeks in a year, a bi-weekly mortgage equals 26 half-payments
a year. The equivalent would be making thirteen mortgage payments a year
instead of twelve. By applying that extra payment directly to the loan
balance as a principal reduction, your loan amortizes more quickly,
requiring fewer payments.
You save money. The ads are true.
How it Actually Works:
You cannot simply mail in half a payment every two weeks to your
mortgage lender. Since they do not accept partial payments for legal and
accounting reasons, the mortgage company would just mail your
half-payment back to you.
Instead, the bi-weekly mortgage company is an intermediary between you
and your mortgage lender. They automatically debit your checking account
every two weeks for half of your mortgage payment, then place your funds
into a trust account. Basically, this is just a holding account for your
money. In another two weeks, there is another automatic deduction from
your checking account, and so on. When your mortgage payment is due,
your funds are withdrawn from the trust account and forwarded to your
mortgage lender.
Since you are placing funds into the trust account faster than your
mortgage payments are due, you eventually accumulate enough money to
make an "extra" payment. The way the cycle works, this occurs once a
year. The extra payment is applied directly to your principal balance,
which causes your loan to amortize faster, pay off more quickly and save
you thousands of dollars.
Potential Problems with the Trust Account
Because your funds are held in the trust account until your mortgage
payment is due, there are potential dangers. Not only are your funds
held in this account, but so are the funds of everyone else enrolled in
the bi-weekly program. That is a lot of money.
Most likely, there will be no problems.
However, if there are accounting errors, mismanagement, or even fraud,
your mortgage payment might not get made. The first hint of a problem
will probably be a phone call or letter from your mortgage lender, but
not until after your payment is already late. Since responsibility for
making the payment rests with you and not the bi-weekly payment company,
you may find yourself digging into your personal savings to make the
payment directly -- even though the bi-weekly payment company has
already collected your funds.
Later you can work out the trust account problem with your bi-weekly
payment company.
The Cost of the Bi-Weekly Mortgage
There is usually a set-up fee that runs between $195 and $350, depending
on how much sales commission is paid to the individual or company
setting up the account for you. You also pay a transaction fee each time
there is an automatic deduction from your checking account and sometimes
also when the payment is made to your mortgage lender. There may also be
a periodic "maintenance fee."
Meanwhile, whoever controls the trust account is earning interest on
your money.
Savings of the Bi-Weekly Mortgage
By making principal reductions using the bi-weekly mortgage program,
your mortgage will amortize more quickly, saving you money. How quickly
your loan pays off depends on your interest rate and when you begin
making the bi-weekly payments.
On a $100,000 loan at today's interest rate of eight percent, your first
principal reduction would probably be a year from now. Assuming the
principal reduction is equal to one monthly payment ($733.76), you would
save $43,852 over the life of the loan and pay it off almost seven years
early.
However, you have to deduct from those savings any amounts you paid in
set-up, transaction, and maintenance fees.
No-Cost Alternatives to the Bi-Weekly Mortgage
Instead of hiring a company to manage your bi-weekly payment, you could
accomplish essentially the same thing on your own for free. Just take
your monthly payment, divide it by twelve, and add that amount to your
monthly mortgage payment. Be sure to earmark it as a principal
reduction.
The first way you save is that you do not have to pay any fees to
anyone. It's free.
In addition to not paying fees -- using the same example as above --
your total savings on the mortgage would be $45,904. Plus the loan would
be paid off three months quicker than with the bi-weekly mortgage. The
reason you save more is because you are making a principal reduction
each month, instead of waiting for funds to accumulate so that you can
make one principal reduction a year.
Self-Discipline?
The bi-weekly mortgage companies claim that homeowners are not
disciplined enough to follow through with principal reduction plans on
their own. They suggest the reason for setting up the bi-weekly mortgage
enforces discipline upon you, and by doing so, they save you money.
However, in this internet age, banking on line and automatic deductions
are readily available. You can set up your own automatic deductions
including the additional principal reduction and have it go directly to
your mortgage lender. Since the deduction occurs automatically, just
like with the bi-weekly mortgages, self-discipline is not a problem.
Once again, you don't have to pay anyone to do it for you and you save
even more money.
Conclusion
The bi-weekly mortgage plans do not really do anything except move your
money around and charge you for it. Plus, even though the danger is
negligible, you must trust someone else to hold your money for you. If
you can do the very same thing for free, plus save yourself even more
money by doing it on your own, why pay someone else?
The bi-weekly mortgage plan - who needs it?
If your goal is principal reduction and saving money, then it is a good
plan. If you do it on your own instead of paying someone else to do it
for you, then it is a great plan.
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