Wednesday, January 21, 2015

Biweekly Mortgage Payments: Why Pay A Company When You Can DIY For Free?

If you have ever taken out a mortgage or refinanced a mortgage, you've likely noticed that right after that process has been completed, you start getting letters in the mail offering you mortgage insurance and other such questionable products. Many of the letters try to fool you into believing they come from your bank by using generic sounding company names like "Loan Payment Administration." They may even reference your loan amount and interest rate. Don't be fooled. The companies that send these letters out are bottom feeders, trying to make money off the financially illiterate. They got your loan information because mortgage documents are publicly recorded. This means anyone can go down to your county recorders office and get a copy of your mortgage. Many states have this information online now - you can get it without even leaving your chair.

After my recent refinance, I received a bunch of these letters but I also received one that promised to save me thousands of dollars in interest and reduce the time it takes to pay off my mortgage by 6 years. This little miracle is accomplished by making biweekly payments - I'd pay one half of my mortgage every two weeks rather than once a month.

To be fair to the company, this will work. By making payments every two weeks, you end up making 13 mortgage payments per year, rather than 12 if you paid monthly. By making that extra 1 payment per year, you will, in fact, reduce the amount of total interest you pay and will pay off your mortgage sooner than normal.

Do It Yourself And Save Money here's the thing: You don't need a company to do this for you. The way these companies make money is they add a service fee to each bi-weekly payment. They may also charge you a one-time setup fee. From the reports I have seen, these companies typically charge a setup (or "administration") fee of $100 - $150 and a bi-weekly fee of $3.50. That bi-weekly fee adds up to $91 per year.

Furthermore, they don't actually make bi-weekly payments to your mortgage company. They hold on to your money and continue to make one payment per month. Then, at the end of the year, they make that extra 13th payment for you.

Don't fall for this scam. As soon as you understand what they are doing, you'll probably realize you can do the exact same thing yourself for free. Furthermore, by doing it yourself, you will save even more money - and not just by not paying unnecessary fees to another company. Here's how:

To achieve the same results that these bi-weekly payment companies tout, simply take your mortgage payment, divide it by 12, and add that amount to each monthly payment you make. (When doing this calculation, use only the principle and interest portion of your mortgage payment. You don't need to include any monies collected for your escrow account, which is usually for property taxes and insurance.) This has the same net effect as making 13 payments per year.

However, compare how doing it yourself works versus doing it through another company. Recall that the third party company still pays your mortgage once per month, but they retain your extra funds until the end of the year. That's when they make that extra payment for you. That means your outstanding principle is not reduced by your extra payments until the end of each year. If you make an additional 1/12th of a payment each month, your principle is reduced a little extra every month. Over the life of the loan, this will result in even greater interest savings for you.

Make Sure Your Extra Payment Is Applied Correctly

Now, if you do go the do-it-yourself route, you need to be sure that you instruct your mortgage company to apply your extra payment towards principle reduction. There is usually a spot on the payment coupon to specify this. (The other option is to apply the extra money to your escrow account. Some companies may instead apply extra payments towards future interest charges by default, which you do not want.)

If you are someone who wants to pay off their mortgage early, this is a popular method for doing so. If I did this on my current mortgage, I'd pay it off 4 years sooner than planned and would save about $22,000 in interest. You can see how much you would save by using the calculator here.


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