Monday, February 1, 2010

Bi-weekly Mortgage Payments

Once you get a mortgage, you will be bombarded with offers for various services. Most of them are outright rip-offs, such as "mortgage insurance", which offers to pay off your mortgage, should you die. I will write more about that in another blog entry. Suffice it to say that a term life policy is a cheaper and better alternative.

But one tempting offer is the bi-weekly payment plan. Is it a rip-off? Well, not exactly. Is is a bargain? Not exactly, either. Does it limit your spending flexibility? Yes.

Before you consider one of these bi-weekly mortgage payment plans, consider the following information very carefully.

To begin with, there are twelve months in the year and 52 weeks in the year. Sounds obvious, but many people miss this basic point. If you pay your mortgage monthly, there are 12 payments in a year. If you pay them bi-weekly, there are 26 payments in a year. Divide this by 2, and you can see you are making 13, not 12 full mortgage payments per year.

The bi-weekly plan divides your mortgage payment in half and then bills you bi-weekly for the amount. Usually, this amount is automatically deducted from your bank account. Many people, who are paid bi-weekly, find this convenient, as the money comes out right about when they get paid, so they can budget their cash flow accordingly. As a result, they worry less about "making the mortgage payment" at the end of the month, and the temptation to spend money is reduced (as that paycheck gets spent immediately, rather than lingering in your bank account until the end of the month).

But you will be paying the equivalent of an extra mortgage payment every year. This means that you will pay off your mortgage more quickly - usually reducing the term of the mortgage by several years. You'll pay less interest as well. These are laudable goals, of course, but since interest is deductible, the overall savings are lessened by that amount.

In addition, some banks will offer lower interest rates for 15 or 20 year mortgages. So if an early payoff is really your goal, then perhaps you should have investigated those instruments rather than a 30-year loan. Not only would you pay off the mortgage faster, you would pay less in interest charges and points as well.

But getting back to the bi-weekly plan, there are other disadvantages to it as well. For starters, if you want to advance the payoff date on your mortgage and pay more in advance, you can already do this. Just make out an extra check every year and mail it in to the mortgage company (or you can even do this online at their website and have it deducted from your bank account). Make sure you indicate on the check (or website) that the amount is to be "applied to principal".

So you can, voluntarily, right now, do what the bi-weekly plans do for you automatically. And when you do this manually, you have the choice of when and how much additional payment to make. If your finances get into a bind, you can decide not to make that extra payment, for example. But of course, the forced-savings nature of the plan is what many people like. Because they know that if they made the extra payment "voluntary" they likely would not make it.

In addition, most bi-weekly payment plans charge extra fees. For example, one plan charges a $250 setup fee, divided by 10 payments, at $25 per payment. And over the life of the plan, they charge $1.50 per payment as a processing fee. These small payments can add up. Over the life of the plan, you might pay over $2000 in fees, which for some folks is an extra mortgage payment.

The bi-weekly plan organizations make money in other ways as well. For starters, they play the "float". They deduct the money from your checking account every two weeks. But the money is held by them until the last minute, when they make the mortgage payment. So in many instances, they may be holding thousands of dollars of your money, interest free, for months at a time (many plans do not apply the "extra" payment until year's end). Of course, with today's savings rates, this may not amount to much, but it is something.

Note also that these plans are usually not administered by the mortgage company, but rather by a third party (usually an insurance company). Most are sound and legitimate, and I have yet to hear of one that has gone under or is crooked. But if the company was to make a mistake and not make a mortgage payment (or pay it late), you would still be responsible for that payment, any late fees, and it would appear as a killer negative on your credit report.

So a bi-weekly mortgage payment plan is not a horribly bad idea. It just is not a super-swell one either. You are not really saving any money (compared to manually making an extra payment), but instead you are trading a small sum for a convenience factor and the "enforced savings" of the plan.

Of course, you can opt out of these plans once you sign up. However, since the sign-up fee (usually $250) is not refundable, if you opt out after signing up, you may owe them the balance of that fee, and also do not get it refunded.

If you are interested in paying down your loan faster, make an additional payment of $50 to $100 a month with each payment (directing the excess toward principal). It will have the same effect, without the fees.

But it is not hard to understand why people sign up for these plans. Most folks have trouble controlling their spending, and if money is taken away from them sooner (as in tax withholding) they are less tempted to spend it all. Many salary slaves struggle every month to come up with the mortgage payment, as it is a rather large sum, and if they are not fiscally responsible, they may have spent most of their money by the end of the month - and not have enough to make the mortgage.

Missing or being late with a mortgage payment kills your credit rating more than any other single event. If you are struggling to pay the mortgage every month, then it is time to make some changes in your finances.

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