Homebuyers who finance their purchase with 30-year mortgages select the 30 rather than a 15 because of the lower required monthly payment. Few like being in debt for 30 years, however, and many seek ways to accelerate the repayment process. Some lenders offer standardized versions of accelerated loan repayment programs, which I describe below, but astute borrowers can do better by formulating their own plan that is hand-tailored to their needs. I have a great tool for that purpose.
On a bimonthly payment plan, the borrower’s monthly payment is split into two pieces of equal size, one due on the 15th of the month and the other on the first. While the borrower makes 24 payments a year instead of 12, they add to the same total. However, the lender credits the half payment on the 15th to the balance on the 15th, which reduces the interest due on the first.
While the reduction in interest shortens the period to payoff, the impact is small. On 30-year mortgages with rates of 6 percent or less, payoff occurs after 719 half payments, shaving just one-half of a month off the term.
There isn’t anything wrong with the bimonthly mortgage, provided that paying twice a month is convenient and you don’t give up anything of value to get it. You can also graft your own accelerated repayment plan onto a bimonthly using the spreadsheet on my website called Extra Payments on Bimonthly Payment Fixed-Rate Mortgages. For example, the borrower with a 30-year $200,000 mortgage at 4 percent who pays $477.42 twice a month gets to a zero balance just half a month early. But if the borrower rounds off the payment to $500, payoff occurs after 659 payments, or 30.5 months early.
A biweekly mortgage is one on which the borrower makes a payment equal to half the monthly payment every two weeks. The payment amount on a biweekly is thus the same as that on a bimonthly. But since there are 26 biweekly periods in a year compared to 24 bimonthly periods, the biweekly produces the equivalent of one extra monthly payment every year.
This results in a significant shortening of the term. For example, the 4 percent 30-year loan converted to a biweekly pays off in 310 months — or 25 years, 10 months. The reduction in payoff period is due entirely to the extra payment every year. Payments are credited monthly, not biweekly, so there is no intra-monthly interest savings comparable to that on a bimonthly.
Note that the benefits of any extra payment program are greater at higher interest rates. The payoff period of 310 months at 4 percent becomes 286 months at 7 percent. These numbers on biweeklies are drawn from another spreadsheet on my site titled Biweekly Mortgages.
A biweekly plan in which payments are credited biweekly rather than monthly would offer little benefit. The payoff period of 310 months cited above would be 307 months if payments were credited biweekly.
Borrowers who like the idea of a simple but disciplined approach to early payoff can do it themselves. By increasing their payment every month by one-twelfth, they will pay off in about the same time as a standard biweekly. At 4 percent, payoff is one month later while at 7 percent it is one month earlier.
The major difference between a plan administered by a lender and one administered by the borrower is that the first is mandatory, providing a discipline that some borrowers may value. Doing it yourself means that you don’t have to do it, which is an advantage to some but a drawback to others.
Your big plan
With programmer Charles Freedenberg, I designed calculator 2a on my website for mortgage borrowers with multiple or atypical income patterns who want to pay off early. The calculator allows the user to schedule extra payments over a range of different intervals and different periods. For example, after borrowing $300,000 for 30 years at 4 percent, Jerry set up the following schedule of extra payments:
- $125 monthly from his monthly paycheck starting immediately.
- $60 quarterly from bond interest payments starting in 4 months.
- $1200 a year from an annual bonus starting in 12 months.
The calculator tells Jerry that if he sticks to the above schedule, he will pay off the loan 86 months early and save $57,666 in interest. If the payments change in the future, which is very likely, Jerry revisits the calculator and updates the results.
Calculator 2a draws more traffic than any other page on my website.
Jack Guttentag is professor emeritus of finance at the Wharton School of the University of Pennsylvania. Comments and questions can be left at http://www.mtgprofessor.com.
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