You've found your dream home. There's one problem: Your monthly household income isn't high enough.
Bi-weekly Loan Programs
(Updated November 2014)
Everyone wants to save money on their mortgage. And if you've spent any time at all discussing savings strategies with friends and co-workers, you've probably heard about the idea of making bimonthly payments.
A bimonthly payment schedule is one of the more well-established "tricks" for saving money on your mortgage with a minimum of effort. There are actually two ways of doing this - one that works pretty well and another that, despite what your uncle, co-worker or assorted friends may tell you, simply does not. We'll talk about the one that works first.
To understand how bi-monthly payments can save you money, let's think about how mortgages work. Normally, you borrow mortgage money from a lender and make one payment per month. During the first years of the loan, the payment usually covers interest charges, but not much principal.
As the loan matures, you nibble away more and more at the principal, which is where the real savings begin to manifest. The faster you can pay off the principal, the more money you can save. To accelerate the process, some homeowners make two half-payments a month instead of one full one. That is, they pay half their monthly house note every other week instead of the full thing once a month.
We generally think of a month as being four weeks long. So usually, if you're going to make two mortgage payments a month, you'll make a payment every
other week. So good so far.
Of course, most months aren't exactly four weeks long. They run two or three days longer than that, and that adds up. As a result, if you make a mortgage payment every other week, there will be at least two months a year during which you'd make three payments. So if you make your payment every other Friday, and Friday falls on the first of the month, you'd also make payments on the 15th and 29th as well - three payments.
Over the course of the year, this works out to making 13, not 12, mortgage payments. And that extra payment goes completely toward reducing your mortgage principle - and therefore shrinking your interest payments more rapidly and hastening the day you pay off your mortgage as well.
Of course, this doesn't work very well if you're paid on a monthly or semi-monthly basis, unless you're a very good money manager - otherwise, how are you going to come up with an additional half-payment out of your single monthly paycheck?
But for those who are paid on a weekly or semi-weekly basis, it's a different story. Paid weekly? Pay half your monthly mortgage payment out of every other paycheck. Semi-weekly? Simply pay half your mortgage out of every check.
Yes, you're paying more of your annual income toward your mortgage payments this way - but you're going it in a fairly painless way. And it not only pays
off your mortgage more quickly, but reduces what you pay in interest as well.
Running the numbers
Here's an example: If you borrow $100,000 at 7 percent interest on a 30-year fixed rate mortgage, your monthly payment of principal and interest will be $661. But what if you make one payment of $330.50 every two weeks? You'll spend exactly the same amount of money, but will reap the benefit of prosperous new math.
Because you're staggering the schedule of payments, you wind up making the equivalent of 13 monthly payments per year. That means that you reduce the life of your loan, without paying anything extra for this clever perk.
The reason it works out that way is that if you pay once a month you make only 12 payments a year. But there are 52 weeks in the year. If you pay every two weeks, you end up paying 26 times. Since you're only paying half ($330.50 versus $661 in our example), divide 26 in half and you arrive at 13 "full" payments each year.
Magically, you've added one full payment. Over the life of your loan, you can reduce your payback by about 5 years with this method and save yourself a significant amount of money.
The not-so-good way
There's another way of using bi-monthly payments that many people swear will enable you to shave years off your mortgage. Unfortunately, it just doesn't
work that well.
Here's how it works: Instead of making one monthly mortgage payment, say on the first of every month, you make two: one on the 1st and one on the 16th. You also make arrangements with your bank so your payment is credited to your account and interest is recalculated on those date, rather than doing so once a month.
The idea is that by paying half of your monthly mortgage payment a bit early, you're reducing your mortgage principal just a bit more quickly - and thereby shaving a bit off your interest payments as well. The idea is that, over the course of a 30-year mortgage, the laws of compounding interest will allow that slight monthly advantage to accumulate into major savings, knocking several years off your mortgage.
The truth is, it doesn't work that well. Yes, paying half your monthly mortgage payment a bit early and getting credited for it will pay off your loan a bit faster, but not very much - maybe one month earlier over a 30-year mortgage. Given that you may have to pay a fee for your lender to set up your loan to handle and properly credit your early payments, your savings may be even less than that.
On the other hand, if you have enough discipline to mail payments every two weeks, you can set up your own bi-monthly program for free and make 13 full payments each year instead of 12.
For the cost of the extra postage stamp each month, you can save yourself thousands of dollars over the life of a 30-year loan. Who said 13 was an unlucky number?
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