The Mortgage Professor
Add Up the Benefits Before Making Extra Payments
Q: My husband and I are paid biweekly. This year I made sure the mortgage payment was made every other paycheck. I figure I will be making one extra payment per year at this pace. Does this really work to our advantage?
A: No. While it may be convenient for you to make a payment every four weeks, you won't benefit if your lender does not have a program that accepts payments on a four-week schedule. I have never seen a four-week payment plan.
Without one, the lender will credit your payment when it is due, not when you send it. You will not shorten the life of your mortgage doing this, and you will give up potential interest earnings on your advance payments.
Many lenders offer biweekly payment plans under which borrowers make half the monthly payment every two weeks. They are especially convenient for people like you who are paid biweekly. If you pay half the monthly payment every two weeks, over the course of a year you make 26 half-payments, which is the equivalent of 13 full payments.
Most biweekly programs credit payments monthly, while a few credit payments biweekly, which is better for the borrower. Crediting payments every two weeks means that the balance is reduced every two weeks, which saves a little interest each month. (You can see exactly how much interest you will save, and the difference in payoff period, by entering the same mortgage in calculators 2b and 2bi on my Web site, and comparing the results. See "Analytical Tools.")
For example, a 30-year, 6 percent mortgage will be paid off in 297 months if the biweekly payments are credited monthly and in 294.5 months if payments are credited biweekly.
So your first task is to see if your lender has a biweekly payment program. If so, ask whether payments are credited monthly or biweekly and what it costs to participate. Costs are relevant, because you have the option of setting up your own program for free. Your decision should depend on whether the convenience of using the lender's program rather than your own is worth whatever the lender is charging for it.
There are two ways to set up your own system. One involves establishing a special bank account into which you deposit biweekly payments and out of which you make your monthly mortgage payment. Every 12 months, there will be enough in the account to make a double payment. This would mimic a lender's biweekly program with payments applied monthly.
A second method closely approximates the results from a lender program in which payments are credited biweekly -- that is, to increase the size of your monthly payment by one-twelfth of the payment. If your payment on a $100,000 loan at 6 percent is $599.56, add $49.96 to it, making your payment $649.52.
Making a monthly payment that includes an extra one-twelfth of the payment is almost as effective as a lender biweekly program with payments credited biweekly. The payoff period in the example given earlier is 295 months, compared with 294.5 months for the lender program.
Not many lenders offer biweekly programs that credit payments biweekly. One that does is Primerica Financial Services, which charges a premium price for it; in the deals that I have seen, the Primerica interest rate is about 2 percent higher than the rate on a comparable mortgage that does not have the biweekly payment option.
Primerica justifies the rate difference by pointing to the lower total interest charges over the life of their loan, relative to a standard loan with a lower rate. This is an invalid comparison because the Primerica loan includes 13 monthly payments a year and the standard loan only 12.
Compared with the simple approach of increasing the payment by one-twelfth every month, the Primerica loan with the higher rate is a big loser.
Jack Guttentag is professor of finance emeritus at the Wharton School of the University of Pennsylvania. He can be contacted through his Web site, http:/
Copyright 2007 Jack Guttentag
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