A co-worker of mine recently received a sneaky sales pitch in the mail after refinancing his mortgage. The envelope said "Payment Information Enclosed" in red letters, which certainly got his attention –and would get anybody's, right? Plus, the way the envelope was addressed made it look like the letter was from his new lender. But it wasn't. It was from a company that wanted to enroll him in a service to pay his mortgage every other week instead of once a month. Basically, you divide your mortgage payment in half and send that half every two weeks instead of sending in the full payment once a month.
Paying your mortgage biweekly is a fantastic way to SAVE BIG but you don't need some sleazy company to charge you a fee –cutting into your savings-- for something you can easily do yourself. There are real risks to turning over your mortgage money to some random company, and I'll share them with you in a moment. As you know, I've turned my column over to the cause of helping people SAVE BIG in this crummy economy, which is also the subject of my upcoming book. So first I'll cover the savings, then the scam.
What really outrages me about the come-on my colleague received is that it claims the savings can be achieved "without increasing the amount of your monthly payment." That's not really true. The reason paying your mortgage biweekly saves you tens of thousands in interest and knocks years off your mortgage is because there are more than 4 weeks in some months, so you do end up paying a little more toward your mortgage when you pay biweekly. You make roughly one extra mortgage payment each year when you use this strategy.
Here's why it works. When you send your money in every other week --which many people like because it corresponds to their biweekly paychecks–you end up sending a little extra.
Specify that the extra is to go toward reducing your loan amount --the principal. The bank bases its interest charges on that principal, so by reducing the amount of principal, there is less for them to charge you interest on over the years.
Let's say you have a $200,000 mortgage. It's a 30-year fixed at 7% so your monthly payment is $1,331. Here's the savings over the life of your 30 year mortgage if you pay bi-weekly instead of monthly, resulting in 13 full payments a year:
Paying Bi-Weekly Instead of Monthly
Interest owed paying monthly (12 payments): $279,013
Interest owed paying bi-weekly (13 payments): $208,115
BIG SAVINGS= $ 70,898
That's impressive! Even better, you will pay off your loan about six and a half years early doing it this way!
So why am I upset about the third party company that wants to set up a biweekly payment plan for people? Here's the catch: companies like that usually charge you $400 to $600 to enroll in their programs. Then they charge you as much as $40 for each payment!
Worse yet, these corporate con artists don't send in the extra payments as you make them. They typically hold them until the end of the month, all the while earning interest on your money. Furthermore, do you really want to send your mortgage payment –the biggest chunk of your income–to some outside company? What if the company is tardy in making your payment, wrecking your credit? What if the company doesn't forward your payment at all? What if the company folds? Don't do it!
Instead, create your own prepayment program. Online banking makes it so easy. And if you still use paper checks, that's doable too. Just add extra to your payment each month and specify that it is to go toward principal. (Make sure your bank does not charge a penalty for early repayment.) Bottom line: paying your mortgage down fast is a way to SAVE BIG. But never pay somebody else for what you can do for free.