Should you choose an accelerated bi-weekly mortgage plan or a vanilla bi-weekly mortgage plan? Odds are if you're asking yourself this question, it's because you want to pay less interest on your home loan. Of course you do and it's not difficult. There are a few different methods you can use to reduce your total interest and pay off your mortgage at a faster rate.
Bi-Weekly Payment Plans
By paying bi-weekly you'll make 26 half payments, or 13 full payments each year—one more than you would make by sending the lender traditional monthly payments.
Every dollar of that extra payment can go towards reducing the principal balance of your loan, the balance that future interest calculations are based on. As you reduce the principal, you reduce the total interest paid and the length of time it takes to pay the loan.
Your lender may not accept half payments mailed to them twice each month, but they'll likely set up a plan to deduct the payment from your bank account every other week. Many lenders charge a one-time fee to set up a bi-weekly payment plan.
Let's look at a mortgage with a principal balance of $150,000, a term of 360 months and an interest rate of 6%.
- Monthly principal and interest payment = $899.33
- Total Interest During Life of Loan = $173,757
Using a Bi-Weekly Option
- Bi-Weekly Payment = $449.67
- Total Interest During Life of Loan = $135,294
- The loan is paid off in 24.5 years instead of 30
Most of us won't live in a single house for thirty years, but don't let that stop you from paying bi-weekly because shorter-term savings are significant.
The first figure on each line below shows the loan's principal balance at the end of that year's monthly payments. The second figure shows how much principal remains at that same time for someone making bi-weekly payments.
$148,157 vs. $147,198 (Difference of $959)
$146,202 vs. $144,224 (Difference of $1,978)
$144,126 vs. $141,066 (Difference of $3,060)
$141,921 vs. $137,715 (Difference of $4,206)
$139,581 vs. $134,157 (Difference of $5,424)
$137,096 vs. $130,380 (Difference of $6,716)
$134,459 vs. $126,371 (Difference of $8,088)
Bi-Weekly Payment Alternatives With an Accelerated Bi-Weekly
A bi-weekly plan forces us to stay on track with additional mortgage payments, but it's not the solution for everyone who wants to reduce their loan principal more quickly. In some cases, a personal accelerated bi-weekly payment plan is the answer. Following are the reasons you might choose this path:
- Your lender might charge a hefty fee to initiate a bi-weekly payment plan
- You might not be in a position to pay extra every month
- You might not be able to pay the same amount every month
- It might be easier for you to make a lump sum payment once each year
One alternative is to divide your yearly payment by 12 and add that figure to each monthly payment, designating it as a payment towards the principal balance. Your loan payment coupon might have a blank line for that purpose. If not, call your lender's customer service department and ask how to make additional payments towards the principal.
For the loan in the previous scenario, you would divide $899 by 12 to find the extra amount to include with your payment, $75.
Your principal balance would equal the following amounts at the end of each year shown. The numbers in parentheses represent the balance due at the same point in time for someone on a bi-weekly plan.
- Year 1, $147,473 ($147,198)
- Year 2, $144,554 ($144,224)
- Year 3, $141,455 ($141,066)
- Year 4, $138,165 ($137,715)
- Year 5, $134,672 ($134,157)
- Year 6, $130,963 ($130,380)
- Year 7, $127,026 ($126,371)
Third Party Payment Plans
There are intermediary companies that will set up a bi-weekly plan for you. They debit your checking account every other week for the higher, bi-weekly amount, then send the regular monthly payment to your lender. Once each year, they'll make your extra payment. Intermediaries charge a fee for the service.
There's no reason to pay a fee for something you can do on your own using another method. What if the intermediary becomes insolvent and doesn't make your payments?
Your lender won't care that it "wasn't your fault" if poor bookkeeping skills result in late payments. It's your responsibility to make payments on time, even if someone else is mailing them for you.
No matter how you do it, making one or more extra payments each year significantly reduces the amount of interest you'll pay on your home loan.
Take some time to play with the numbers using online mortgage calculators. You might notice slight variations in the results from different sources, but the figures should be close enough to help you to evaluate your options.