13: A Lucky Number for Mortgages
Sometimes an old idea is the best idea. In August of 1982, five-year conventional mortgage rates were priced at 18.25 percent. That was an improvement over the year before when the rate peaked at 21.75 percent. Homeowners were sweating, and not just from the heat. To help cool things off, credit unions came up with a novel but simple idea – bi-weekly mortgage payments.
Surprisingly Big Savings
Bi-weekly payments are the easiest and most effective way for borrowers to save thousands of dollars in interest. To understand how they work to your benefit, take a look at the following example. Henry and Anne borrow $142,772.35 at 7 percent per annum, calculated half-yearly, not in advance, and amortized over 25 years. Their blended monthly payment (principal and interest) is $1,000. Over the next 25 years, they will repay their mortgage in full, plus $157,227.49 in interest – a total of $300,000 over the life of the loan.
But if Henry and Anne cut their conventional monthly payment into two bite-sized pieces, paying $500 every two weeks instead of $1,000 each month, it chops the interest expense to $124,238. That saves them $32,989 in interest – the equivalent of $50,000 or more in extra income, since interest is generally paid in after-tax dollars.
How It Works
Bi-weekly mortgages work because of an accelerated reduction of principal. Each year contains 12 months but 26 two-week periods. By paying $500 every two weeks, Henry and Anne are sneaking in an extra payment every year, reducing their mortgage by $13,000 instead of $12,000. Since interest is charged on the outstanding principal, every extra penny reduces what's owing, cutting the total interest cost.
Getting the Real Deal
Unfortunately, not all bi-weekly mortgages are calculated correctly. Some lenders will simply take the total amount paid annually, and divide it by 26 to get the bi-weekly payment. Unless your conventional monthly payment is divided in two, the accelerated payment concept will be compromised.?
How can you be sure you’re getting the real deal from your lender – a payment schedule that effectively slashes five years off your amortization? Arm yourself with a calculator. Negotiate the best possible rate, ignoring the issue of weekly payments. Ask the lender for the normal monthly payment, amortized over 25 years. Then halve that figure to get the bi-weekly payment you want to set up. If you want to pay weekly, take the normal monthly amount and divide by four – you’ll be making 52 payments a year, instead of the equivalent of 48.
Contact Creative Arts to discuss bi-weekly, or even weekly, payment options for your next mortgage. We’ll also show you how much money can be saved with different amortization options.
Call us at 416-642-6749 or 877-643-3660. We’re here to help you find the right mortgage for your current cash flow and your long-term goals.