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More Payments, Less Cost?

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Posted On: 06/01/2011

QUESTION:

If it's true that a bi-weekly mortgage lowers the interest cost for a mortgage then why not get a bi-weekly mortgage and reduce annual costs, too?

ANSWER:

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A bi-weekly mortgage does not reduce annual loan costs, it increases them.

Imagine you have a $100,000 mortgage at 5 percent fixed over 30 years. The monthly cost for principal and interest will be $536.82. Over 30 years interest on the loan will amount to $93,256.

Now imagine the same mortgage paid on a bi-weekly basis: Each payment will amount to $268.41 and the total lifetime interest for the loan would be $76,907.

So yes, over time the interest expense would be smaller with the bi-weekly. However, the annual cost would be greater.

Look at the numbers: With the annual loan you're paying $536.82 by 12, $6,442.

With the bi-weekly you pay once every two weeks, not twice a month. This means there will be 26 payments per year. Multiply $268.41 by 26 and the annual cost for the bi-weekly is $6,979.

The bi-weekly results in a lower lifetime interest cost because annual payments are being increased. In our example, the bi-weekly loan would be repaid in roughly 25 years. Not making five years of payments - and having less principal outstanding along the way - is largely how bi-weekly loans save money.

Rather than a bi-weekly loan, and rather than refinance, check with your lender to see if prepayments in whole or in part without penalty are allowed. If OK, just increase your monthly payment for principal and interest by 8.5 percent - you'll get the same result as a bi-monthly without having to send in 14 extra checks, additional checks a lender can refuse to process.

Do it yourself and there's no fee to set up a "program," no extra charge with each payment, and if things get tight you can just go back to making your required loan payment without the voluntary prepayment.

Peter G. Miller is the author of The Common-Sense Mortgage and a veteran real estate columnist. Have a question? Please write to peter@ctwfeatures.com.

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