I was reading a blog post about mortgages recently and noticed that it said “biweekly payments – you do this right?”. This is a tactic that’s brought up often, but I haven’t thought about it for a while. While I was very interested when I first heard about it at this point I don’t consider it very important.
The idea makes sense – if you take a regular monthly payment and pay half of it every two weeks, you’ll pay off your mortgage a lot sooner. There’s no magic in it though; it simply comes from a change in timing that results in two extra payment per year. The actual difference – if any – would come from paying slightly lower interest for the second half of the month. Other than that it’s just a way of increasing your regular payments. For many people it’s possible to just pay a little more, either by increasing the regular payments or choosing a shorter amortization. Biweekly payments could be useful for those who don’t think they can save the extra money for two weeks but I don’t plan my finances around that.
The post that brought this up was in the context of when to break a mortgage and get a lower interest rate. In that case, it might be possible that you can change from monthly to accelerated bi-weekly payments and not pay a penalty or have it count as a regular payment increase (I don’t know how banks view this), which would be good if you want to increase your payment. In any other case, if you manage your money well it seems that it isn’t really necessary.
Since I manage everything on a monthly basis I would actually prefer to have one or two larger payments per month than to keep the smaller payments and have two months with an extra payment – it’s not a big deal, but the advantages of biweekly payments aren’t that big either.
What do you think? Should everyone use biweekly payments? Do you or would you?
May 9, 2009 at 6:34 pm
It’s a psychological trick. It’s a way of increasing your payment without really feeling the emotional hit that otherwise might be associated with doing so.
It’s the sort of thing that the credit card companies would come up with to entice us to go deeper into debt, except that here the tactic is being used in reverse. So it seems to me that its a pretty darn good thing.
I wouldn’t do it because I have a more advanced set of tricks that I use to help myself see the value of not being in debt. But it sounds to me to be a good beginner’s trick.
The important thing is to use SOME sort of trickery on yourself. We are emotional creatures. Trickery works on us. If it didn’t, the credit card companies and all the others trying to enslave us in debt wouldn’t devote so much of their mental energies to coming up with these sorts of things.
Rob
May 10, 2009 at 12:46 am
Exactly my plan – my trickery is to think about the potential results from investing a little bit more or paying off a debt a little bit sooner frequently, so I get excited any time I have a chance to do it. At this point I’m more of a compulsive investor than a compulsive spender!
May 10, 2009 at 3:47 am
I don’t have a mortgage yet myself but everything I’ve read definitely advises to pay as frequently as you can. I’ve heard the same argument with credit cards, too. Since interest is calculated daily usually, it helps to put as much on as you can as often as you can to keep the balance lower. So it might work similarly with a mortgage; it might not be a *total* trick – although I agree with that aspect too.
Congrats siliconprairie, for being a compulsive investor:)! I’m kind of one, too, but I haven’t got *all* my spending under control yet.
May 10, 2009 at 4:12 pm
If interest is calculated daily it would be a small advantage to move to biweekly or even weekly payments, especially if the earlier ones are mostly considered principal payments. But in that case I don’t know why some websites would say “interest calculated semi-anually not in advance” – it’s something I’ll need to ask about when the time comes.
June 8, 2009 at 8:12 pm
Just to nitpick a little here, the big savings come with accelerated bi-weekly, not merely bi-weekly. For non-accelerated bi-weekly they just take your yearly amount and divide it by 26 (52/2), with accelerated they divide it by 24 (12*2). So accelerated actually means you make the equivalent of an extra 2 payments a year.
For example on a 200k, 25y, 4% mortgage you only save $1,241 switching to bi-weekly, but $16,972 switching to accelerated bi-weekly, so those extra payments do make a big difference.
You could do almost the same by either decreasing your mortgage term (to say 22 years instead of 25), or depending on if your mortgage will permit it, make a larger payment each month.
Finally, on the ‘semi-anually…’. Here’s a good resource http://tinyurl.com/nzhts9 . Basically it means they don’t just take the interest rate and divide it by 12 to decide on your monthly interest, because they would end up taking too much. Instead they figure out how much you’d pay if the charged you twice a year, and work out the equivalent periodic rate to equal that. (The site explains it better then me).
June 9, 2009 at 2:32 pm
It’s interesting that even regular biweekly payments can make a difference – this probably depends on how the bank applies the payments. The best thing is really to find the shortest amortization you can afford, use any payment schedule that suits you, and then increase payments when you have extra cashflow.
Thanks for the link. That explains a bit more but it will still take some time for it to sink in. It looks like it means the interest compounding can only apply every 6 months, but other than that the payments are applied as you would expect.