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monthly
payment is and then cut it in half, and start making this
half-payment every 2 weeks. Because there are 52 weeks in a
year, you end up paying the equivalent of 13 monthly
payments instead of 12 (26 bi-weekly payments which equate to 13
monthly payments).
So, what are the benefits to you?
There are really only 2 main benefits:
- More Principal Paid - You
end up paying 1 extra payment per year, which will means that
you contribute more toward your principal. This benefit
is the most significant in terms of dollars. This
translates into you being able to pay off the principal
sooner...and thus cut the mortgage term.
- Lower Interest Charges -
You are not only paying an extra payment per year...you are
also paying more frequently. So, because of your more
frequent payments, the interest expense charged to you is
slightly less, because the bank has their payment sooner than
waiting for it every month. This benefit is much smaller
than the extra payments mentioned above...but any savings is
good savings.
Sounds good? It sounds good
to us too, but....
The
Problem with Bi-Weekly Plans?
Lenders who offer this
plan don't do it just for your best interest in many cases.
Instead, you are typically charged in one or possibly 2 ways:
- Setup
Fee - Your lender will require an up front fee to set up
the administration portion of the plan. I have seen the
charges range from $300 to $500 for this. This fee is
almost always charged.
- Per
Transaction Processing Fee - This fee is charged for
monthly servicing of the extra payments. For example, a
company might charge $2 for each bi-weekly payment. This
fee may or may not be charged.
While
you do obtain the benefits that I mentioned above for this plan,
there are some major problems with it. First, the
extra trouble that it will take for you to write a check every 2
weeks is a hassle (if you don't elect to do automatic
withdrawals). Second, you end up paying your lender to do
something that you could easily do yourself!...You can
duplicate the bi-weekly plan results without paying any of the
setup and per transaction fees.
How
Can I Duplicate the Bi-Weekly Plan?
It's
really very simple. Simply take your normal monthly payment
and then divide it by 12. Take this amount and add it to your
normal monthly payment. Voila...you are now getting the same
results as if you were on a bi-weekly payment plan.
Let's
look at an example:
Sam
J. has 20 years left on his note, with an outstanding balance of
$179,325, with an annual interest rate of 8%. His normal
monthly payment is $1,500. He has decided to implement his
own personal "bi-weekly" plan so that he can pay off his
mortgage more quickly. His new monthly payment will be
$1,625 ($1,500 + ($1,500/12)). If he makes this payment
every month, he will duplicate the bi-weekly plan offered to him
without having to pay anyone to "administer" the
plan...as well as avoiding monthly payments.
But.
does it really work...can it match the results that a bi-weekly
plan would give to him? Let's see the results:
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Example:
$179,325 mortgage balance at 8%
|
| |
Normal
Payment Plan |
The
"Official" Bi-Weekly Plan |
Sam's
Own Personal Plan |
| Outstanding
Balance at Beginning of Year |
$179,325 |
$179,325 |
$179,325 |
| Monthly
Payment |
$1,500 |
$750 |
$1,625 |
| Total
of Payments Made |
$18,000
($750 * 12) |
$19,500
($750 * 26) |
$19,500
($1,625 * 12) |
| Total
of Interest Payments |
$14,209 |
$14,152.76 |
$14,142.80 |
| Total
of Principal Payments |
$3,791.00 |
$5,347.24 |
$5,357.20 |
| Outstanding
Balance at END of Year |
$175,534 |
$173,977.76 |
$173,967.80 |
|
Set Up Fee |
$0 |
($400) |
$0 |
|
Monthly Service
Charges ($2 per payment) |
$0 |
($52) |
$0 |
| Total
Net Worth Increase (Principal Paid - Fees) |
$3,791.00 |
$4,895.24 |
$5,357.20 |
As you can see, simply prepaying
your mortgage every month, adding 1/12 of a payment on top of the
normal payment, will give you almost exactly the same results as a
bi-weekly payment plan...AND without paying having to pay the
setup and monthly fees!
WrapUp
So, basically, if you have the discipline to simply make your own
payments, you can duplicate the results of the bi-weekly plan.
It's easy to do...and you will increase your net worth and your
financial discipline...and see your mortgage debt paid down
faster!
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