Math Magic – Bi-Weekly Mortgages

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By PETER ROSENTHAL, President
V.I.P. Trust Deed Company

For my inaugural column in the Glendale Gazette, I have decided to revisit an old friend: the bi-weekly mortgage. If you own a house or a piece of property anywhere in the United States, you are probably making a mortgage payment to a private party or conventional lender, i.e. bank/mortgage company. If so, this column should be of great financial interest to you. If you don’t own a piece of property but are planning to purchase a piece of property in the future, read on. Maybe you have a friend or relative who is about to purchase or refinance. For the remainder of you reading this column, read on anyway; this is a fantastic topic for the next cocktail party. The other guests will think that you are a real Real Estate guru.

Bi-weekly mortgage programs became extremely popular approximately ten years ago. Between 1990 and 1995 a whole industry sprang up selling bi-weekly mortgages. The pitch was, “Pay half of your mortgage payment every two weeks through Company X and Company X will save you $10-20-50,000 or more over the life of your loan. In fact, you will pay your mortgage off approximately ten years earlier JUST by paying half of your normal payment every two weeks.” All of this is true, however–HOWEVER–the catch is that there is a fee of approximately $400 to set up this program with Company X at the local county fair, trade show or wherever. “What is $400,” you say, “if I can save $50,000 or more over the life of the loan?” You are right, however I will now show you how to do it for nothing and you can donate $400 to your favorite charity. If you don’t have a favorite charity, drop me a note and I will give you mine. Just kidding.

The bi-weekly program is nothing other than the two magic words I have been preaching for over a quarter of a century. For all those years the Rosenthal financial magic has been “PAY MORE.” The bi-weekly mortgage and the Rosenthal magic are actually the exact same thing, except the bi-weekly mortgage “tricks you” into believing that you are paying the same amount of money monthly. Nothing could be further from the truth.

Let’s assume for the sake of simplicity that your normal 30 year loan payment is EXACTLY $1,000. The payments for one year are therefore $12,000. The bi-weekly plan divides that into two and you only pay $500 per period. The trick is that you believe that means twice a month, when in reality it is every two weeks. Is there a difference? There sure is. There are 52 weeks in a year and therefore 26 bi-weekly (every other week) periods. 26 X $500 = $13,000, which is exactly $1,000 more than $12,000 or, in fact, one extra month’s payment. That’s right, for a $400 set up fee you can be suckered into paying $1,000 more per year than you were before. The only redeeming feature to this plan is that it is somewhat painless and is, in fact, a forced savings. Is this worth a $400 set up fee? Heck no. Let’s do it the Rosenthal way.

Assuming the above payment of $1,000 a month, merely pay an extra $83.33 per month and you will have accomplished the EXACT same MIRACLE. If you are short during the year, just pay an extra $1,000 when you get your tax refund, birthday present or whatever. The simple trick is to pay one extra payment per year, or more if you can. In this example, perhaps you can pay $100 extra per month rather than $83.33 To show you how this magic really works, I will run the following three examples. In the first example the payment is $1,009.41 per month. In the second example, I have increased the payment to $1,093.53, which is exactly one extra payment per year (just like the bi-weekly). In the third example we are paying $1,100 per month because, frankly, I figured you wouldn’t miss the extra $6.47 per month. Here’s how it breaks down:

In all three following examples the principal amount is $100,000. The interest rate is 11.75%. I picked this strange interest rate as it was as close as I could get to a $1,000 monthly payment. The amount is amortized over a 30 year period.

Math Magic Table

As you can see, in example two, which is virtually the same as the bi-weekly plan or Rosenthal magic, you save $110,002.75 in interest and 128 months of payments. That is over TEN years in payments! Example three is simply Rosenthal magic plus a little extra. In this example, compared to example one, you save $114,050.00 in interest and 133 months of payments.

Now that you have learned the magic, some of you believe that your lender will only accept a “regular” payment. Again, nothing could be further from the truth. The typical monthly mortgage payment is really very simple. Interest is charged for one month, based on the loan balance from the previous month. Any extra payment can ONLY be credited to principal. This therefore further reduces the principal balance and the following month, interest accrues only on the smaller balance. The only exception to this would be if a regular payment is $1,200 and you were to send a payment of $2,400. Without specific instructions, the lender would either credit this as a $1,200 extra principal payment or the lender might be confused and credit it as two separate months of regular payments, i.e. January and February. The simplest way to solve this problem is to put a note with each overpayment stating “apply overage to principal.” Perhaps we will get into the actual amortization process in a later column, and you will see how this actually works.

The moral of the story here is to overpay your loan whenever possible and save many, many thousands of dollars in future interest. Don’t get suckered into bi-weekly plans when you can, in effect, do it yourself. Do not, however, send less than a regular payment as the lender is not set up to accept anything other than a regular OR HIGHER payment.

Hopefully this column will give you food for thought, extra money to spend or save and, as importantly a great cocktail party topic. If, for some reason, I have not made this crystal clear, I will be happy to explain this individually. The two words “PAY MORE” are intended to save YOU thousands of dollars, and not intended to line anyone else’s pocket with fees and costs.

Peter Rosenthal
VIP Trust Deed Company