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David Bach The Automatic Millionaire

David Bach, The Automatic Millionaire

How to Save Big on Your Mortgage

by David Bach

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Posted on Monday, July 16, 2007, 12:00AM

Like some of my fellow Yahoo! Finance columnists, I'm often asked if it makes more sense to prepay a mortgage or invest the money in stocks and bonds. Rather than ponder which asset will get you a higher return, I think the better question is which investment decision will free you financially and allow you to retire earlier.

In my 9 years of experience as a financial advisor for Morgan Stanley, the clients who paid their debts off early -- specifically their mortgages -- retired 5 to 10 years before those who didn't.

If your goal is to retire sooner than your friends, sleep well at night, and save a lot of money over time, here's the best approach I know of prepaying your mortgage.

Going Biweekly

When you set up a biweekly mortgage payment plan, instead of making your monthly mortgage payment the way you normally do you split it down the middle and pay half every two weeks.

The result is that you end up making one extra full payment every year. (Twenty-six half payments is the equivalent of 13 full payments.) The best part is that the extra payment is made gradually over the course of the year, so you don't feel the pinch. And since most people are paid every two weeks, a biweekly payment plan turns out to be a phenomenal budgeting tool.

Anyone can do this. You don't need a special mortgage, and you can set it up anytime.

Pay More, Save More

Say your mortgage payment is $2,000 a month. With a biweekly plan, instead of sending a $2,000 check to your mortgage lender each month, you would send them $1,000 every two weeks.

By doing this, the miracle of compound interest reduces your debt. You actually end up paying off your mortgage early -- somewhere between 5 and 10 years early, depending on the duration of your loan and your interest rate.

On average, a U.S. homeowner with a $300,000 mortgage can save upwards of $100,000 over the life of his or her mortgage just by following this simple program. And if that's not enough incentive, think about being debt-free and potentially ready to retire years sooner than you'd planned.

Let's compare the difference between a monthly and a biweekly payment plan for a $300,000, 30-year mortgage with an interest rate of 7 percent. The monthly payoff schedule winds up incurring a total of $418,026.69 with interest charges over the life of the loan.

The biweekly schedule, on the other hand, runs up just $311,876.19 with interest. So switching to the biweekly plan will save you more than $106,000. Your mortgage may be smaller or larger, so run the numbers for your mortgage to see how much you can save.

Automate It, Of Course

The great thing about switching to a biweekly payment plan is that it allows you to save money over the long run without refinancing or otherwise changing your mortgage. All it takes is one call.

Most mortgage lenders offer programs designed to totally automate your biweekly mortgage plan. At Wells Fargo, for example, it's called the Accelerated Ownership Plan. Citibank calls it the BiWeekly Advantage Plan. To enroll, all you need to do is phone your lender or go online. Many banks even offer this service for free to customers who do their banking with them.

Banks that don't offer this service will usually refer you to an outside company that runs the program for them. These companies generally charge a setup fee between $200 and $400. In addition, there's a transfer charge of $2.50 to $6.95 each time your money is moved from your checking account to your mortgage account.

To be sure you're dealing with a reputable firm, I recommend using one that's referred to you by your mortgage company. One of the biggest such firms is a company called Paymap Inc. It currently provides this service through its Equity Accelerator program, which is powered by Western Union. To find out more, visit their web site or call (800) 209-9700.

(By the way, I'm not affiliated with Paymap or Western Union in any way, and I don't make money by recommending them. Whenever I mention a specific service or product in my column, it's simply to offer a resource for readers -- not to get a commission.)

What to Ask Before Signing Up

When dealing with a service company, be sure to ask the following critical questions:

• When exactly do they fund the extra payments toward your mortgage?

The answer should be "immediately." You're making extra payments to pay down your mortgage faster. That won't happen if the service company is holding onto your payments for any reason.

• What happens if you refinance?

Determine whether the service is transferable to a new mortgage company, or if you'll have to go through the setup process again -- including paying another fee.

• How much will it cost to use the program?

Get a clear understanding of how the costs involved compare to the savings you'll realize, so you can make an informed decision (see the next section).

Cost vs. Savings

Let's do the math. If you're paying $2.50 per transfer every two weeks, that comes to roughly $65 a year. Over 22 years, it totals just over $1,430, not including the setup fee. Figure that the transfer fee will probably go up a little over time, and there's no question that a biweekly mortgage system will cost you a few thousand dollars.

So why do it? The answer is that the few thousand dollars you're spending will save you tens of thousands of dollars, if not more.

In the example above, you would've saved more than $106,000 over the life of the mortgage. Assuming that you signed up with the most expensive program out there to handle your biweekly payments, and spent $5,000 over 22 years, you're still ahead over $100,000.

Going It Alone

Are there other, no-cost mortgage prepayment options? Sure. You could pay an additional 10 percent of your mortgage each month and have it applied directly toward the principal. Or you could make one extra payment at the end of the year and again have it go toward your principal.

But note that word "could" -- some things are much easier said than done. Just as most people won't save if they don't make it automatic, most of us won't make extra mortgage payments unless it's automated.

If you decide to do it yourself, my suggestion is that you pay an extra 10 percent a month and send it as a separate payment -- automatically, of course. Make a point of telling your lender to apply any extra payments toward your principal, and then check your monthly statements to make sure they've applied it correctly.

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136 Comments

Showing comments 6-35 of 136<< PreviousNext >>
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  • Yahoo! Finance User - Wednesday, August 1, 2007, 12:37PM ET  Report Abuse

    • Overall: 4/5

    Very good article. A must read for most mortgage/home owner...

  • Mary Ann - Wednesday, August 1, 2007, 12:01PM ET  Report Abuse

    • Overall: 5/5

    Great advice we have a refinace coming up in November! Is your last name really Bacchiocchi ????? Just wondering ??? If so I have family with the same name !!!

  • Richmond - Sunday, July 29, 2007, 11:49PM ET  Report Abuse

    • Overall: 1/5

    Do not setup a biweekly payment plan. All you manage to do is accelerate interest payments to the bank. If you must, add something extra that goes toward principal only. This way you will build some equity. The biweekly program is not sound financially as the bank knows that you will likely move or refinance in less than 10 years and suckers you to make faster interest payments.

  • RaymondG - Sunday, July 29, 2007, 11:47PM ET  Report Abuse

    • Overall: 1/5

    RayRayG With all the nickle and dime fees, your better off to invest in a good mutual fund that will return 10 to 20% per year.

  • Edie - Friday, July 27, 2007, 8:24PM ET  Report Abuse

    • Overall: 1/5

    What! Why pay people to do what you yourself can do for free? Bi-weekly payments are one of the biggest scams

  • BobH - Friday, July 27, 2007, 6:36PM ET  Report Abuse

    • Overall: 3/5

    Bi-weekly and twice a month are not the same thing. If you make a mortgage payment every two weeks there will be some months when you will have an extra payment pulled from your account. There has to be at least two months out of the year that there will be an extra two week interval in the month to fit 26 payments in 12 months. If you run tight on your account balances you may get a surprise overdraft notice once in awhile. Either keep a high enough balance in your account to cover the extra amount or buy overdraft protection.

  • Yahoo! Finance User - Thursday, July 26, 2007, 4:12PM ET  Report Abuse

    • Overall: 4/5

    I knew the math. I thought I will make an extra payment worth of one month payment every year. Never did that. You know how it goes. If you set it up with your financing company, you are obliged to pay that. So I think it certainly is a good practice to setup this bi-weekly, as long as you can make that extra payment.

  • Yahoo! Finance User - Thursday, July 26, 2007, 3:16AM ET  Report Abuse

    • Overall: 1/5

    Not only is the math very poor in calculating both payments and interest but you would be better off saving the cost of setting up the program and bi-weekly maintenance by adding a principal payment to your monthly mortgage. Yes, this requires some discipline, though you can make the payments automatically, and every investment advisor will tell you learning discipline is a good thing. Furthermore, if your financial condition changes, you can increase or decrease the extra payment amount as appropriate. You don't have that option with the bi-weekly contract.

  • Henry - Tuesday, July 24, 2007, 8:44PM ET  Report Abuse

    • Overall: 1/5

    This is only good advice for people close to retirement. Paying off your mortgage early denies you a good tax credit. Furthermore, you don't get the benefit of inflation making your payment less "valuable." Say you're paying $2000/month per month on your 30-year fixed rate mortgage. Perhaps that seems a lot right now and you're eager to get the monkey off your back... but in 30 years, because of inflation, $2000 is going to be worth much, much less. Your mortgage is going to stay at $2000, but your salary is going to increase with inflation, so as time goes on your mortgage payment becomes less and less painful.

  • LA - Tuesday, July 24, 2007, 8:39PM ET  Report Abuse

    • Overall: 1/5

    why not just make an extra principle payment a month? just take the extra payment you'd make using the bi-weekly method, divide it by 12 months and send that extra in as a "principle only" payment or just make one extra payment a year. a mortgage is a great tax benefit. why not pay off high interest debt first?!

  • Ira - Tuesday, July 24, 2007, 8:34PM ET  Report Abuse

    • Overall: 5/5

    This is the best advise I've heard and really easy to implement. Thanks.

  • TomH - Tuesday, July 24, 2007, 8:24PM ET  Report Abuse

    • Overall: 1/5

    Sure, you could pay off your mortgage by using bi-weekly payments, but don't forget to think about: 1. If you have enough money to not worry about doing this, you probably are rare. Most people I know enjoy those few months where you get a third paycheck, which helps catch up on bills or pay for a vacation. 2. Sure, your house will be paid off, but after 20-25 years, with a typical inflation average of 3% it's not nearly the same amount of money. Hopefully your real estate has appreciated, though... 3. Most people are not going to live in the same house for 20-30 years, but rather move around. If you're typical, I think you're spending no more than 5 years in a house, and those first 5 years of payments don't put much into the principle. You're better off getting an interest only loan in this case and taking the extra and putting it in the bank or some other investment. 4. Basically what everyone else is saying...the house is a tax write off while you are making payments.

  • Yahoo! Finance User - Tuesday, July 24, 2007, 8:15PM ET  Report Abuse

    • Overall: 1/5

    Has this guy ever taken a math class? A $300,000 loan at %7 interest and less than $12,000 in interest if paid bi-weekly. Something doesn't add up.

  • Grace - Tuesday, July 24, 2007, 7:24PM ET  Report Abuse

    • Overall: 4/5

    We switched to biweekly several years ago. it is nice to see the extra payment each year going right to principal.

  • Yahoo! Finance User - Tuesday, July 24, 2007, 7:12PM ET  Report Abuse

    • Overall: 4/5

    Very interesting. I will look into it.

  • jojo - Tuesday, July 24, 2007, 6:26PM ET  Report Abuse

    • Overall: 5/5

    The best advice I have heard in a long long long time... Thank You, your a genious !!!!!!!!!!!!!!!!!!

  • Cory - Tuesday, July 24, 2007, 5:39PM ET  Report Abuse

    • Overall: 5/5

    Wow, after reading alot of posts I know I'm in the right business. 99% of people don't know anything about their mortgages and how they work.

  • Rich C - Tuesday, July 24, 2007, 5:32PM ET  Report Abuse

    • Overall: 3/5

    I believe in paying what you can. I am a 100% commissioned salespaerson so some months it is hard to pay extra and other months I can afford a lot extra. Just so long as it ends up as an extra payment per year it doesn't matter how you get there. This way I am not pressured into the extra payment in the lean months. Wells Fargo payment slip allows you to put extra payment 100% to principle.

  • peter - Tuesday, July 24, 2007, 5:27PM ET  Report Abuse

    • Overall: 2/5

    1

  • Steve - Tuesday, July 24, 2007, 5:14PM ET  Report Abuse

    • Overall: 1/5

    First, the writer doesn't even factor in the fact that your house is your biggest tax write off. Paying it off early, of course, will reduce or even eliminate your biggest write off. Second, investing in a quality mutual fund will, over time, outperform the interest rate you pay on your mortgage by a wide margin, thus making it a much better way to go.

  • MicheleS - Tuesday, July 24, 2007, 5:04PM ET  Report Abuse

    • Overall: 2/5

    I think that this makes something that is so simple much more difficult. I add 1/12 of my annual payment to each monthly check, the payment slip has my extra money specifically marked toward principle. This way, I'm making that extra payment, don't have to worry about paying it twice a month and don't have any extra charges. You don't need to be a financial analyst to figure out that this works better than what is suggested in the article.

  • mps1168 - Tuesday, July 24, 2007, 4:54PM ET  Report Abuse

    • Overall: 3/5

    I find it easier for me to pay an extra $100 a month on my $1150 per month mortgage. By year end I paid an extra $1200 on principal and garner the net result. I realize as stated some do not have the will ower to make the "extra" payment each month so do what works best for you.

  • Joe - Tuesday, July 24, 2007, 1:00PM ET  Report Abuse

    • Overall: 3/5

    To easily make that extra payment each year, you need to be budgeting and tracking your budget. Here is a FREE online budget tracking application to help you do this: http://www.checkthebudget.com

  • Joice - Monday, July 23, 2007, 9:45PM ET  Report Abuse

    • Overall: 1/5

    talking abot benefits without conditions really misleads readers. If you are lucky and got a low interest rate couple years ago, I could not see why he need pay ASAP. Even the conservertive saving interests of many banks are current already higher than the mortage, which loaned few years ago.

  • Rachel - Monday, July 23, 2007, 5:26PM ET  Report Abuse

    • Overall: 4/5

    Good advice.

  • John - Monday, July 23, 2007, 12:55PM ET  Report Abuse

    • Overall: 2/5

    This is good info, BUT YOU MISSED THE BEST WAY TO SAVE BIG $$ ON YOUR MORTGAGE! It's a new program called the Money Merge Account and it beats the bi-weekly program by HUGE margins and thousands of dollars. The best you can do with a bi-weekly is save 7 years off your mortgage. How about taking 12-22 years off your mortgage! That is exactly what we are doing with the MMA program- taking 15 years off of our 30 year mortgage and it is all done just by re-structuring the way we do our banking and using some of the bank's money interest free. It's a great program and is saving us TONS of money off of our loan plus has helped our monthly cashflow. We went to this website to see if we qualified- I guess you should have a FICO score of at least 620 or have a HELOC that is not maxed out- www.u1stfinancial.net/johnfechik . We watched the Money Merge Account Flash Video and then filled out the financial analysis. An agent called us and went over the results and we are now set up on the MMA and loving it!! I would recommend this over the bi-weekly anyday. When you do the math, you'll see for yourself, too!

  • creativeart - Sunday, July 22, 2007, 11:56PM ET  Report Abuse

    • Overall: 3/5

    It is really very easy to pay off yur mortgage yourself- just strictly write down every penny you spend in a 30 day period - and then cut out some of the snacks, lattes-etc and send that extra money directly to the mortgage holder as prepaid principal- forget about adding an extra layer of "service". There is nothing more satisfying than sitting at a coffee or other over-priced venue and enjoying overspending for a treat- knowing that yur mortgage is PAID OFF and you deserve this!!!

  • Dave W - Sunday, July 22, 2007, 11:15PM ET  Report Abuse

    • Overall: 4/5

    First I feel there was too much discussion on setting up the payment account. If your mortgage lender does not offer this service, then your primary checking/savings provider should. If neither can accommodate, then consider moving to a savings/loan provider that is a bit more 21st century. I do not agree with a direct correlation that people paying down their debts retired 5 to 10 years earlier than those who don’t. A) I doubt this was a proper survey and analysis and B) often people paying down their debts early are those who have exhausted other options. ddrobinett points out Ben Steins column where Ben states 'On the other hand, if you have plenty of stocks according to your investment advisor and a huge surplus of cash -- which many people do have -- you might well want to use some of that to pay down your mortgage.' While it may be true, those who retire early have paid their mortgages down faster, it is more their accessibility to cash that gave them this privilege, not the fact of paying down the mortgage. With all that being said, I am actually set up on the biweekly program for 2 reasons. It reduces the individual impact of any one mortgage payment on my monthly cash flow (more of an emotional benefit) and for me it is a seemingly invisible investment opportunity. I still keep the discipline to save for retirement in the same manor as when I had a monthly mortgage, but now my a bit more of my disposable income is going into my house – which looking at how I had spent my disposable income in the past, I am able to shave a little here and there for the greater good. Note that I do not look at this as an either or option against investing in an index fund – I feel employing both strategies is a key to a happy and stress free retirement. Keep in mind, this does put a little more structured stress on your monthly cash flow. Using the 10% overpay per month gives a little more flexibility to adjust it month to month depending on other financial burdens – perhaps overpaying 10% for 10 months out of the year, and paying the standard amount in the month that involves a summer family vacation and a month around the December holidays. Automation is a great thing, but it also limits some of the flexibility which is one fear many homeowners have – flexibility with their income to not increase their already high payment to income ratio.

  • John - Saturday, July 21, 2007, 7:08PM ET  Report Abuse

    • Overall: 1/5

    Bad advice. If you have a 6% mortgage, its more like paying 4%, since the interest lowesr your taxes. Over 30 years, you can easily make 10% a year in a well diversified stock index fund. 10% 4%. Duh.

  • D-Bone - Saturday, July 21, 2007, 5:47PM ET  Report Abuse

    • Overall: 1/5

    http://finance.yahoo.com/expert/article/yourlife/37252 I'll take the advice of a Columbia/Yale grad who was a presidential speechwriter at 30 over this guy any day of the week, and twice on Sunday.

Showing comments 6-35 of 136<< PreviousNext >>

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