Your mortgage is probably your biggest monthly expense, and saving money on it could make a significant financial difference in your life. One popular money-saving option you may have heard of is a bi-weekly payment plan for your mortgage. It can save you money in the long run, but it will increase your annual expenses for now. Keep in mind that not all financial institutions have bi-weekly payment plans in place, so you should always consult them on the best way to make more frequent payments according to their policies.
How does a normal monthly payment plan work?
With a normal mortgage, you make 12 payments each year, and these payments are typically due on the same day each month. If you follow the monthly payment plan, you will pay off the mortgage within the time frame specified when you got the mortgage, which is usually either 15- or 30-years.
The monthly payment has two components. First, your money goes to pay all accrued interest, which is calculated based on your outstanding balance and interest rate. Then the remaining portion of your payment goes to pay the principal balance, which reduces the amount you owe on your mortgage.
Early in the repayment of your mortgage, most of each payment goes towards paying interest and only a little bit pays down the balance of your loan. As your balance decreases, so does the interest portion of each payment, so more of each payment goes toward further reducing your mortgage balance.
What is the difference with a bi-weekly payment plan?
With a bi-weekly mortgage payment plan, you make half of your usual mortgage payment every two weeks, rather than one payment every month. Because there are 52 weeks in the year, you will end up making 26 payments, which is the equivalent of 13 full payments. It works this way because months are not exactly four weeks long. For example, if you are making a payment every other Friday, some months will have four Fridays and other months will have five.
The main advantage of a bi-weekly payment plan is that it helps you pay off your mortgage more quickly, which lowers the amount of interest you'll pay over the loan term. In the months with three bi-weekly payment dates, you will be making an extra half payment on your mortgage. The first two half payments that month will have paid all the interest for the month, so the last payment goes directly toward reducing your principal balance.
An example is helpful here. If you purchase a home with a $200,000 mortgage at 3.9% interest, you will have a monthly payment of 943.34 for a 30-year loan. Making bi-weekly payments of $471.67 will result in you paying off the loan in 26 years rather than 30. You will also pay $21,548 less in interest charges.
What mortgage payment plan is best for you?
If you get paid every two weeks, it can be helpful to be on biweekly payments because they line up evenly with your paychecks. However, if you get paid monthly or bi-monthly, it is easier from a budgeting perspective to stick with monthly payments.
When you are on a tight budget, you may be better off sticking to your regular monthly payment plan rather than making bi-weekly payments. The money you are thinking about putting toward extra payments could be put towards better use, like paying off high-interest credit card debt or saving for retirement.
The higher your mortgage interest rate is, the more advantageous it is for you to make bi-weekly payments. This is because the two extra half-payments help you reduce your principal balance more quickly. As a result, you will pay less interest on each future payment. If your interest rate is low, you will not see as much of a savings impact by making extra payments.
The closer you are to retirement, the more beneficial it will be for you to pay off your mortgage early and own your home free and clear. Making bi-weekly payments can help you achieve this goal and decrease your expenses during retirement.