Today’s blog is stolen from my friend, Mike Hall, also at Pacific Residential Mortgage
We’re all looking for the “good deal”. Often, it’s right in front of us, rather than off in the distance.
The idea of paying your mortgage twice a month is not new. It’s been around for a long time, and comes in a few different flavors. The most common setup is called a “bi-weekly”. You pay half of a normally scheduled payment every two weeks. Either the regular loan servicer or sometimes a third party offers this with the popular notion is that it’s a good deal and provides big savings over the life of the loan. They usually charge a significant setup fee of something like $300-500, and then a payment processing fee of a few dollars with every payment made. The promise is that the loan is paid off years earlier and saving thousands…or tens of thousands of dollars in interest.
For almost everyone, it’s neither a big savings, nor a good deal. It’s just math. And it doesn’t necessarily work out in your favor. Here’s how it works:
Notice that in a bi-weekly, you pay every two weeks, not twice a month. There’s a difference. There are 52 weeks in a year. Paying every other week, there are 26 payments. Each is half of a normal payment. Twenty six half-payments is the same as 13 whole payments. All you’ve done is made an extra payment. You can do that without a bi-weekly plan, without committing yourself to the higher cash flow, and without the fees.
Not only that, but the claim that you can save thousands misses the forest for the trees. The question isn’t whether you can pay your loan off faster, its “should you”. What??? Sacrilege!!! Surely it’s better to pay off sooner and save all that money, right??? Well, if you could save thousands on a new Rolls Royce, should you run out and buy one? See my point?
Paying off a loan faster may be dangerous for this simple reason: Most folks have insufficient savings. We should build emergency savings, and then more. Savings for life, for college, for disability, illnesses, or transitions. Or from a more positive light…we should have savings for investment and opportunities that come along and require fleeting moments of liquidity. We should build savings in places we can get at, because it does no good to stuff a bunch of cash into the walls of your house and then seal it up with sheetrock. You can’t get to it when you really need it. I have yet to see someone with a foreclosure looming or an unexpected disability who wishes they’d put more money into their house. They all wish for one thing. Cash. And if you save that cash in a reasonably secure place, earning anything near the rate on your mortgage (not too hard to do), you can come out ahead by NOT paying off faster.
The only borrowers whom I’d give the green light to on accelerating their mortgage payoff are the folks that already have a TON of savings, and are in no risk of being cash-poor. And even then, it may not be good. For most folks, the best deal is in paying your normal scheduled payments, combined with an aggressive savings plan…outside the walls of your house. It is the truly conservative thing to do. If you do things right, you’ll be safer, more secure, and maybe even richer in the end.
By the way, there are 4.3 weeks in a month, not 4. It’s not magic…it’s just math!