Claim: Switch to bi-weekly payments, and you can reduce the amount of time it takes to pay off your house dramatically.
Truth? Yes, but...
Situation: I recently saw an advertisement in a magazine that claimed you could cut the time it takes to pay off your $100,000 mortgage at 8.5% from 30 years to roughly 20 years by going for bi-weekly payments, (please sign your name here and send us $395...). The ad went on to say that, instead of paying $1100 per month, you just split your payment into $550 every two weeks. (Note: The amounts used in this ad do not conform to regular blended mortgage rules).
The Truth: $1100 per month for 12 month works out to $13,200 per year in payments. On the other hand, a year has 52 weeks, and if you pay every two weeks, you pay 26 times a year. $550 per bi-week for 26 bi-weeks works out to $14,300 per year in payments. Therefore, by paying biweekly, you pay the equivalent of 13 monthly payments, i.e. one extra payment. That is the largest reason you pay off your mortgage faster, not the fact that you pay bi-weekly. The bi-weekly payment will make a slight difference, but not much (roughly 5 month).
The fact of the matter is: you can achieve the same thing by making the equivalent of one extra monthly payment (you can do that by either amortizing your mortgage over 20 years from the beginning instead of 30 years, or making yearly principal payments). Most banks offer what is called a ‘short term mortgage’. Your monthly payment is higher, but the amortization (time required to pay off your mortgage) is shorter.
What do you gain from paying off your mortgage faster? You save large amounts of money in the long run. Instead of paying $1100 per month, you pay $1192 per month, but you pay off your mortgage in roughly 20 years, thereby saving (according to the ad) roughly $65,000 in interest payments. Remember, you can do this without changing your mortgage to bi-weekly payments, just by getting a ‘short term mortgage’.
How do you want to pay for your mortgage? You should pay for your mortgage according to how you get paid. If you get paid monthly, you should pay monthly. If you get paid bi-weekly, you should pay bi-weekly. If you get paid semi-monthly (1st and 15th, or twice a month), you should pay semi-monthly. And if you get paid weekly, you should pay weekly. This way, you don’t find yourself in a situation where you miss a payment, because you have not been paid yet.
In conclusion: Pay your mortgage accordingly to when you get paid. Adjust the length of your mortgage by changing the amortization period. If your bank does not want to play by those rules, find another one.
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