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Bi-Weekly Mortgage Alternative

A popular option these days is to set up a bi-weekly mortgage payment program.  I never have been a huge fan of this option, primarily because the marketing of the program is driven by the fear of paying large amounts of interest.  Thus, the program looks like it is saving you a lot of money by paying your mortgage off quicker.  The main reason for the savings in interest cost is not due to paying it off quicker but due to making an extra payment, in other words saving more money.  What this marketing does not show is:

  • The savings will by offset be loss of mortgage deduction (so actual savings will be less)

  • For the $100 to $400+ to set up such a program, you are hiring someone to force you to make the extra payment which you can do yourself for no cost

  • If the extra payment was invested in other savings vehicle (like stocks), the savings could be as large (or larger) (see Should I have a mortgage? for more information)

    If you invested $110 a month into a savings plan at various rates, you will have the following amounts at the end of 23 years and 10 months ( about the time when mortgage is paid off with a bi-weekly mortgage).

    4% savings plan - $52,000

    7% mortgage interest - $80,000

    8.5% return (stocks/bond mix) - $101,000*

    10% return (stocks) - $128,000*

    * Note, the outstanding mortgage after 23 years and 10 months without the extra payment would be approximately $80,000.  So you could technically pay off your mortgage with the investment returns and still have money left over (if markets perform up to expectations).

    So in reality, it was the decision to save, not the biweekly mortgage program which will save you money.  The first choice is whether to save the extra money.  The second choice is how to invest that extra savings whether it is by paying of your mortgage quicker, by building up an emergency fund (in a savings plan) or by investing in stock and bonds.

In addition, by making an extra payment

  • For many, an already tight budget just gets tighter

  • You lock yourself into new mortgage payment and what happens if you lose your job or become disabled?

There is nothing wrong with making an extra payment to pay down your mortgage quicker.  Yet, do it wisely.  Many suggest paying the $100 to $400 or more to sign up for the program because it forces you to save.  If you really want to save, then make a conscious decision and write a checks for 1/12th of the extra payment each month.  You will get the same results with the added flexibility of dropping the extra payment if times get tough.

Making the extra payment with a bi-weekly program will probably eat up 2 to 4% of a typical budget.  For many, this may not seem like a lot.  Yet, when your are living paycheck to paycheck already, the additional payment is a lot of money when there is already little to no room.  In addition, many new home owners do not consider the extra expenses that a new house brings in the first few years (e.g., new furniture, carpeting, drapes, a fresh coat of paint, etc.).  So, an extra payment becomes a bigger deal.

A better option may be to increase your mortgage by the amount of your pay raise each year (e.g., 3% to 4%).  Typically, the average pay raise will keep up with inflation and sometimes an extra increase for merit or promotion.  Each year, many expenses will also increase due to inflation except for your mortgage payment which is fixed.  Thus, when a family has lived in their house for 10 or more years, they start to feel some breathing room due to making a mortgage payment based on cost of housing 10 or more years ago.  Thus, they have extra money to spend on any number of different things.  Some may buy a new house because with their pay raises and a new 30-year mortgage, they can afford a bigger house.  However, after doing this a few times, they then start to wonder why they still have a mortgage in retirement.

By increasing your mortgage each year instead of spending on other things, you will save even more money than a bi-weekly mortgage.  The bi-weekly mortgage will be paid of in about 24 years.  A mortgage that is indexed 3% each year (what we can call a PayRaise Mortgage) will be paid off in approximately 18 years while saving 18% on interest costs of a bi-weekly mortgage. 

The added advantage is that indexing your mortgage will not create the initial burden that a bi-weekly mortgage payment does because the additional mortgage payments are phased-in as your pay increases.  The key here is that the universe provides us more of what we are feeling and believing.  Thus, if you feel that money is a struggle due to the additional payment of a bi-weekly mortgage payment, then the universe will continue to provide you with struggles.  If you ease into a higher mortgage payment by indexing it along with your pay raises, it makes life easier (less of a struggle of how to pay all your bills).
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