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Most people have a mortgage payment that is paid on a monthly basis and most mortgages are 30-years in length based on amortization. This a very simple plan: you pay for 360 months and the house is yours.
The thing is that you have the option to pay the loan down at any pace that you desire.
Biweekly Payment Option
Many mortgage companies and service providers offer a biweekly option where you will pay half your monthly amount every two weeks. With 52 weeks per year, paying biweekly means there will be 26 biweekly payments.
Under this structure, you will make 13 payments rather than the standard 12. When using this payment scenario under a standard 30-year mortgage, you can save thousands of dollars in interest.
Payment Plan Scenario
Let’s take an example of a mortgage at $325,000 at 3.5% interest for 30 years: -The standard mortgage payment comes to $1,459.40.
-When opting for the biweekly route the payment is cut in half to $729.70.
Let’s look at the reduction in the total interest:
-Interest amount for 30 years would come to $200,382
-Interest under a biweekly payment comes to $171,194
The difference is $29,188 dollars and the mortgage would also be paid off in 26 years and two months.
An additional point of note is that if you carry PMI, a more agressive payment plan will speed up the time to drop it. Read PFT# 4 What is PMI and How to Get Rid of it.
Understanding the Payment Plan rules
One piece of the equation is to make sure that your mortgage payment processor offers a biweekly plan. Some offer it is a standard and if you need to go back to normal payments it shouldn’t be a problem.
Before choosing this path verify there are no prepayment penalties on your loan and that the extra payments are applied to the principal balance first rather than to principal plus interest. You always want all of the money used toward the principal.
Making the Payments On Your Own
If a biweekly program is not offered do not pay a processing company to do this work. It is common that they’ll charge a setup fee and perhaps monthly fees.
To do this on your own, go online and make the extra payment every month and you're all set.
Food for thought: many financial purists will not make extra payments (Podcast #9) on the mortgage. Some choose to invest the extra money in the stock market through tax-deferred accounts such as 401(k), after-tax accounts such as a Roth IRA or an individual brokerage account.
Many in the financial world stick to the notion that making 6% year-over-year is feasible. Hence, if you are paying 3.5% mortgage interest as in our example, the math says you are better off investing it.