How A Bi-weekly Mortgage Works
In a bi-weekly mortgage, one half of a monthly payment is paid every two weeks. That means that in a year with 52 weeks, 26 bi-weekly installments are made. If each of those installments is one half of a monthly payment, 13 monthly payments have been made in 12 months, with that extra month being applied directly toward the principal.
That is to say that, in just 12 years of paying on a loan, a homeowner will have made a years worth of extra payments, all being deducted from the principle amount.
For homebuyers who can afford it, this option allows them to own their home outright much sooner and pay less in interest over the term of the loan.
Existing mortgage holders must pay a fee to switch from a monthly plan to a biweekly, but the same effect can be easily achieved (as long as your lender does not charge a prepayment penalty) simply by putting half of your monthly payment, every two weeksmost likely paydayinto a special bank account from which you pay your mortgage. Then, each month, when you make your monthly payment, pay out the balance of that account.
As an example, a standard 30-year mortgage fixed at 6% on $125,000 (excluding PMI and property tax), taken out on January 1st of 2010, will yield monthly payments of $749. In twelve years, at the end of the year 2022, $95,701 will still be owed on the principal.
The same loan agreement with a bi-weekly payment option will yield an additional $8,988 by that same year ($749/year x 12 years). All of this being applied to the principal amount, the owner of this mortgage now owes $86,713 on the principal. Since the monthly payment is static, for that principal amount, the owner pays a monthly interest-to-principal ratio equivalent to that they would pay during year 14 of the loan. This means paying down the principal quicker.
With a biweekly payment (or its equivalent), this homeowner would pay of this loan five and a half years sooner than the 30 year plan, and pay $113,696 in interest versus $144,797 saving more than $31,000.
When looking into a mortgage, a buyer should always inquire about bi-weekly payment options and if there are fees to change from a standard fixed rate mortgage to one with a bi-weekly payment schedule.
When comparing lenders there are myriad mortgage calculators on the internet that will provide monthly amortization tables. While there are some that will even compare standard monthly to bi-weekly schedules, to understand it yourself, calculate the initial monthly payment for a standard fixed interest mortgage using an online calculator. Then, on the amortization table, find the principal left at the end of year 12 with the standard payment schedule and subtract from it 12 times the monthly payment. Find that new principal amount on the table.
The payments made at the beginning of year 13 will be whatever follows the new principal amount, which will be laid out on the chart a couple years ahead of time. This varies depending on the size of the loan and the interest rate.
It will be apparent that the beginning of year 13 will bring a much larger percentage of the monthly payment being credited toward the principal.
There can be significant differences in the exact way lenders treat bi-weekly mortgages, so be sure to ask each lender directly how theirs works.
When researching mortgages you should look at both yours and your spouses income and develop a top-end limit. If you are considering a bi-weekly payment schedule on a 30-year loan, you may also want to look into a 15-year fixed schedule. The monthly payments may be high, but, over a twelve month span, how much does the total increased payment compare to an extra months payment on a 30-year mortgage? Can you afford this?
Ask lenders what the costs are to change a mortgage to a bi-weekly schedule from a monthly schedule, and if the mortgage you are inquiring about has prepayment penalties. This will ensure you flexibility with your mortgage no matter what option you choose.
If you hold a mortgage agreement that charges to switch to a bi-weekly schedule but you still wish to do so, there are third parties who will set up an account for you and debit the bi-weekly payment directly from your checking account. They charge a small fee, but it may or may not be less than the one your bank charges.
In the end, if you can afford the extra payments, a bi-weekly schedule will build equity in your home faster, help you own your home sooner, and save you thousands in interest. However, always use discretion and read the fine print when making any changes to your loan agreement and, if possible, consult a financial advisor.