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Early Payment Options for Mortgage Borrowers

The Mortgage Professor: Mortgage repayment: Questions about systematic extra payment plans

Feb. 26, 2016

By JACK GUTTENTAG The Mortgage Professor - Tribune News Service

For many borrowers, it is easier to accelerate the pay down of a mortgage balance if the process of making extra payments is routinized.

Then the extra payments become a habit.

The questions posed below apply to plans of this sort.

Q: What is a bi-weekly mortgage and how does it work?

A: A bi-weekly mortgage is one on which the borrower makes a payment equal to half the fully amortizing monthly payment every two weeks.

Since there are 26 biweekly periods in a year, the bi-weekly produces the equivalent of one extra monthly payment every year. This results in a significant shortening of the period to payoff.

For example, a 4 percent 30-year loan converted to a bi-weekly pays off in 310 months -- or 25 years, 10 months.

Q: For whom does a bi-weekly make sense?

A: It makes sense for borrowers who have the capacity to pay more than required but need the discipline of a well-defined routine.

Q: Do all lenders offer a bi-weekly option?

A: No, and some of those that do charge for it.

But you can always create your own.

Open a bank account into which you deposit half the payment every two weeks, and withdraw the full monthly payment every month for submission to the lender. At the end of a year, there will be enough in the account for a double payment.

Q: Are there any approaches that don't require a special bank account?

A: Yes, the simplest is to increase the scheduled monthly payment by one-twelfth.

If the payment is $1,200, for example, you remit $1,300. Doing it this way will actually pay off the loan a little sooner than using a bi-weekly because the loan balance begins to decline with the first payment rather than after a year.

Q: What is a semi-monthly mortgage?

A: A semi-monthly mortgage is one on which the borrower makes half the fully amortizing monthly payment on the 15th of the month, and the other half on the first of the month.

In contrast to the biweekly, there are no extra payments, but payments are credited twice a month rather than once a month.

That is the only source of benefit to the borrower, and it is small.

On 30-year mortgages with rates of 6 percent or less, payoff occurs after 719 half payments, shaving just one-half of a month off the term.

Q: For whom does a semi-monthly payment make sense?

A: It may make sense for any borrower who finds that making payments twice a month is convenient, and whose lender offers the option at no cost.

You cannot roll your own semi-monthly, because it is wholly dependent on the willingness and ability of the lender to credit payments twice a month.

Q: Is there any way to add extra payments to a semi-monthly?

A: Yes, borrowers who are using a semi-monthly can add to their payments in any way they like, and I have developed a spreadsheet that is designed to help them.

It allows you to assess the impact of additional semi-monthly payments on your payoff period.

For example, the borrower with a $200,000 mortgage at 4 percent who pays $477.42 twice a month gets to a zero balance just half a month early without extra payments. But if the borrower rounds off the payment to $500, payoff occurs after 659 payments, or 30.5 months early.

Q: What is a weekly payment mortgage?

A: A weekly payment mortgage is one on which the fully amortizing monthly payment is multiplied by 12 and divided by 52 to get the payment made every week.

There are no extra payments and the weekly payments are credited to the borrower's account only once a month. The weekly payment does not result in an early payoff unless the borrower makes extra payments.

The lender may charge for offering the facility.

Q: For whom does a weekly payment mortgage make sense?

A: The only borrowers who might benefit are those who are paid weekly and place a high value on the budgetary discipline imposed by having to pay their mortgage weekly.

Q: Is it true that the payoff period of a mortgage can be cut in half if the borrower doubles the principal payment each month?

A: Yes, it is true, but there is an important proviso.

The extra payments required are larger than the principal payments that are customarily displayed as part of an amortization table, because such tables assume that there are no extra payments. For the scheme to work, the extra payment in each month must match the actual principal payment in that month, which amount has been affected by prior extra payments.

This means that the required extra payment has to be recalculated every month.

Q: For whom does a doubling-of-principal scheme make sense?

A: It makes sense for a nerd with rising income.

You have to be something of a nerd to appreciate having to recalculate the required extra payment every month.

And you also must have the capacity to raise the ante every month.

For example, in using this technique to pay off a 30-year 4 percent mortgage of $280,000 in 15 years, the required extra payment would rise from $403 in month one to $597 in month 60, to $889 in month 120, to $1325 in month 180.

Q: How would the mortgage professor accelerate the payoff of his mortgage?

A: He would develop an extra payments plan using a special calculator he and Chuck Freedenberg designed specifically for this purpose.

The calculator provides maximum flexibility in defining extra payment intervals, amounts, and durations, and it shows the payoff period for any combination of these factors.

With this calculator, I can design a program that is geared exactly to my own unique needs, and monitor the progress from month to month.

About the Writer
Jack Guttentag is professor emeritus of finance at the Wharton School of the University of Pennsylvania.

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Copyright (c) 2016, The Mortgage Professor

Distributed by Tribune News Service.

This story was distributed by TNS - Tribune News Service
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