Bi-Weekly payment programs, are they a good idea?
I am often asked by customers whether or not signing up for a bi-weekly repayment plan is a good idea. So that this post doesn’t exceed 10,000 words I am going to ignore the first question to ask which is “should I be in a hurry to pay off my mortgage?” given that you probably have a low fixed interest rate which carries tax advantages. In other words, are their other financial goals that deserve more attention (i.e. building a liquid savings account for security, paying off other debts, boosting retirement savings, boosting college savings, etc.)?
In general I oppose the bi-weekly payment plans because I think the companies that offer them deceive consumers. Here’s why:
With bi-weekly payment programs the lender or a 3rd party servicer will typically charge $250-$500 to sign up for the program. They will then automatically draw one half of your total monthly payment every 2 weeks and apply it to your mortgage. The marketing materials for these programs lead consumers to believe that the reason they are paying down their principal quicker is because they are paying one half of their mortgage payment earlier in the month and therefore avoiding interest on that portion of their mortgage payment during the second half of the month. But this is not accurate.
The reason that a bi-weekly plan accelerates the principal reduction on your mortgage quicker than the regular amortization schedule is NOT because you’re making the payment earlier in the month but because you are making 13 payments per year instead of 12 (there are 52 weeks in a year, 26 bi-weekly periods, and therefore 13 total payments made).
With that said, any consumer can create the very same impact by simply making one extra payment per year or by increasing your monthly mortgage payment by 1/12th of your principal and interest payment. For example, if your monthly principal and interest payment is $1,200 per month then you could add $100 per month (1/12th of $1,200) and have the same impact as the bi-weekly payment program without signing up or paying a fee.