SHOULD I PAY BI-WEEKLY OR JUST PAY EXTRA PRINCIPAL MONTHLY TO ACCELERATE MY MORTGAGE?
By Kathy Genz CRS CDPE GRI QSC SRES, Broker Associate, RE/MAX Properties, Inc
This post is a follow up to my post on this blog on March 20, 2010. Many banks offer bi-weekly payment programs for borrowers to be able to prepay their mortgage easily and conveniently. It is automatic and you just have to remember to make sure to put that payment in your check register every 2 weeks. In effect, you are making an extra month's payment every year that goes towards paying down principal by making payments 26 times throughout the year of an amount of half your normal monthly payment, rather than making 12 monthly payments.
BEST OPTION?
But is this really the best option? If you have difficulty putting money into savings every paycheck, this may be the best option for you because it is automatic and pays down your mortgage without you having to think about it. Most people are not disciplined when it comes to money. If you are one of the disciplined people out there, another option may fit you better. And that is to pay that same amount of extra principal with your regular monthly payment. You can still set up automatic payments through your electronic bill payment service at your bank or through your mortgage lender. But you do have to let your lender know the extra is going towards principal and not escrow for your taxes and insurance. The benefit is that you actually pay down your mortgage faster by doing it this way!
I'm sure you've heard of the concept of buying term life insurance, which has lower premiums in the earlier years than whole life, rather than buying whole life and then putting the difference you save between the 2 types of insurance in investments instead. The only problem is that the majority of people never put the difference in investments. A bi-weekly mortgage payment works the same way. If you need the discipline of a structured program, then a bi-weekly program (or whole life if you are buying insurance) can get you where you'd like to go financially.
MORE CONTROL
If however, you are a person who likes to have more control, will pay the extra towards principal every month, and wants to have more equity at the end of every year than you would with a bi-weekly program, then using an automatic payment that you control can get you there even faster. Doing it this way also allows you to increase the amount of extra principal paid as your income increases or as you pay down other debt and have additional money you can apply to your mortgage. But, in any event, it is always good to pay extra toward your mortgage if your goal is to increase the equity in your home. You can compare by using a bi-weekly calculator and a mortgage payoff calculator and looking at the difference in your principal balance at the end of each year. These calculators are readily found on the web. I found a bi-weekly calculator at bankrate.com. Your own bank probably has one or both on their website.
TURNING A 30 YEAR INTO A 15 YEAR LOAN
If that isn't enough, let me give you one more way to accelerate your payments and turn your 30 year mortgage into a 15 year mortgage without having to commit to a 15 year payment schedule. Pull out your amortization schedule for your mortgage or create one on any of the mortgage payment calculators available on the internet. The bank where you having checking and savings probably has one on their website. Now, look at the amount that goes into principal each month from your payment. When you make your next payment, double the principal. If the principal portion is $200, add $200 to your next payment. You are effectively getting rid of one payment every time you do that. And you can see that if you keep it up, your interest portion keeps reducing and the principal portion keeps growing. You get rid of half your payments over the life of the loan. This works because the ratio of principal to interest is calculated every month as your balance declines, so you accelerate your principal reduction. What a deal!
FLEXIBILITY
So, you decide whether a structured method that is automatic or a more flexible method that can still be automatic is the best choice for you. The advantage of the flexible method is that you can change the extra amount at any time, either increasing, decreasing, or eliminating it, or by adding lump sums (like your tax refund) to one payment to accelerate the loan even faster. You choose. Until the real estate market provides appreciation once again, principal reduction is a good way to add value to your home and to your net worth. Isn't that part of the reason you purchased real estate to begin with? Don't ignore this powerful tool for creating wealth.
MORE INFORMATION
To learn more about strategies like these, visit my blog at kathygenz.com. New posts are uploaded regularly. We even have restaurant reviews on Thursdays! Join us online.
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