Many homeowners with a traditional mortgage may at some point or another come across an idea or suggestion from someone that a biweekly payment plan for their mortgage will help them save money. Some people may also receive offers in the mail from third party companies to set up a biweekly payment plan for their mortgage payments by evidencing thousands of dollars of interest cost savings. As your preferred lender, we feel that it is our responsibility to educate our customers about the reality of biweekly payment options before you commit to such payment plans. We would like to take this opportunity to discuss the biweekly payment plan in more detail, while at the same time deconstruct the myths and misconceptions associated with it.
PLEASE NOTE THAT SUN WEST IS *NOT* IN ANY WAY AFFILIATED WITH ANY OF THESE COMPANIES THAT SELL BIWEEKLY PAYMENT PLANS. SUN WEST DOES NOT SOLICIT OR ENDORSE ANY SUCH OFFERS OR PRODUCTS IN ANY WAY OR FORM.
One of the most common reasons that people may consider making biweekly mortgage payments is the ability to coincide such payments with employers’ paycheck schedules. Since most companies or banks offering a biweekly payment plan require automatic bank drafts, a biweekly payment plan helps you gain the convenience of automatically paying your mortgage payments on time without the need to worry about missed payments or having to write multiple checks every month.
Most companies advertise the biweekly payment plan with two additional benefits: the ability to improve credit scores through more frequent payments and the ability to pay off the mortgage faster than scheduled. We will look at both the advertised claims in more detail below.
Claim #1: Making two payments for your mortgage instead of one improves your credit score. It is a misconception that increased payment activity due to the increased frequency of mortgage payments will help improve credit score. The action of making two mortgage payments versus one in a particular month has technically the same effect. An individual’s overall credit score improves partly due to the history of on time payments. Whether you make 26 biweekly payments or 12 monthly payments in the same period, the relative effect on your credit score will be the same.
Claim #2: A biweekly payment plan reduces the amount paid toward interest. This is the biggest selling point of the biweekly program by some of the third party companies. They claim that when you pay additional principal at the end of each year through 2 additional biweekly payments, you are effectively reducing the amount of interest that you will pay over the life of your mortgage. This is true to a certain extent, but in practice, it is NOT the best option available to you and we will soon see why.
Understanding your options
Let’s take a look at this table to understand the various payment options available to you, then we will discuss which offers you the highest savings, assuming a loan amount of $200,000 at a rate of 5.5% on a 30 year fixed rate mortgage:
|STANDARD MONTHLY PLAN||TRUE BIWEEKLY PLAN||BIWEEKLY ACCELERATION PLAN||PREPAYING 1/12TH OF PAYMENT EVERY MONTH|
|Offered By||Most Mortgage Banks||Select Mortgage Banks||Third Party Companies||Most Mortgage Banks|
|Total Interest Paid During Life of Mortgage||$208.808.08||$208.610.48||$169,369.15||$167,757.47|
|Payment Amount Per Year||$13,626.96||$13,620.36||$14,762.54||$14,762.54|
|Effective Term (In Months)||360||359.3||301||299|
Understanding A True Biweekly Plan
A true biweekly plan is a payment option usually offered by the mortgage servicer. It is important to note that not all mortgage servicers allow this payment option. Under this plan, you receive one statement every two weeks, with each payment amount being a little less than half of your normal monthly payment. You make 26 biweekly payments during the year under this plan. The annual total of these 26 biweekly payments will be almost the same as the annual total of 12 standard monthly payments. Essentially, you derive the same effect through either of the two options on an annualized basis.
Understanding A Biweekly Acceleration Plan
The most commonly advertised and sold biweekly plan, primarily through the mail, is the “Biweekly Accelerator Plan (BAP)”. This plan is primarily offered by third party companies and effectively requires 13 full payments in a year when compared to 12 payments under a standard monthly payment plan. Unlike a True Biweekly Plan discussed above, the annual total payments under a BAP does not equal to the annual total paid on a standard monthly plan. When you choose BAP, a third party company will require you to make exactly half the amount of a standard monthly payment every two weeks, and since there are 52 weeks in a year, you will be making an additional 1 month of standard payment on your mortgage every year.
Essentially, a biweekly acceleration plan is just a regular monthly payment plan with additional prepayment, equivalent to 1 month of standard mortgage payment. Some borrowers will generally misconstrue a BAP to be a better payment method that will help reduce their compound interest while paying the same yearly amount, but this is not the case, because a borrower will be required to pay extra as prepayment.
Prepaying with 1/12th of your monthly payment every month – the smartest and best solution
As you read above, a Biweekly Acceleration Plan is essentially a monthly payment plan with a 13th monthly payment toward principal prepayment. This is not the best option available to you when it comes to interest costs savings. You will be saving more on interest by simply paying an extra amount equal to 1/12th of your standard monthly payment toward principal when you make your regular monthly payment to your servicer. The calculation is simple. If you have a $200,000 mortgage at 5.5% for 30 years, your monthly payment amount will be $1,135.58. Take $1,135.58 and divide that by 12 to get $94.63. Send in an extra $94.63 as a prepayment towards principal every month with your regular mortgage payment of $1,135.58. By doing this, you will save a total of $41,050.61 over the life of your mortgage while paying off your home 5 years early.
Additionally, here are some of the reasons why you should choose a 1/12th prepayment method if you wish to pay off your mortgage faster:
You will be more in control of your money. If you are interested in paying off your mortgage early and are willing to apply extra prepayments, you should manage the prepayments yourself. By managing your own payments rather than letting a third party company manage it for you, you reduce the risk of mismanagement and at the same time, you will be making sure that your money goes directly to your servicer and will be properly applied to paying off your mortgage.
No commitment required. Under a biweekly plan, you are obligated to make those extra payments on time every month. With self-managed prepayments, you have the flexibility to pay either more or less than the 1/12th amount each month or to skip it entirely if you decide to put that money towards something else.
Additional costs to consider. Most third party companies will charge a fee anywhere between $250-$400 dollars to set up a BAP. Also, there is a good chance that you will be charged another small biweekly service fee (about $2.00) for doing an automatic payment transfer, which means paying upwards of another $1,440 over the life of your mortgage. In this tough economy, every penny counts, and you should save wherever possible.
We hope this educational resource has helped you understand how a biweekly payment works and how you can execute a better strategy through a more flexible option of prepaying 1/12th towards the principal every month. You can increase or decrease your prepayment amount as necessary, unlike the biweekly options which are not as flexible. Please use our calculators to compare your prepayment options, or contact one of our customer service representatives by calling 1-800-453-7884, and we will be more than happy to assist you over the phone.
You may Click here in order to access the actions taken by CFPB for false advertising regarding the Biweekly payments.