Financial column: Are biweekly mortgage payments right for you?
Published 12:00 am Sunday, May 23, 2004
By Dan W. Panzer, Financial tips
If you are one of the many American homeowners who have recently refinanced their mortgages and are in the fortunate position of having more expendable cash each month, you may be considering whether or not you should pay off your mortgage early. One common way to accelerate your payment cycle is to change it from monthly to biweekly. However, as with most financial decisions, you should first review the advantages and disadvantages of this strategy and consider your alternatives.
Biweekly mortgage plan
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Setting up a biweekly mortgage payment plan can save you thousands of dollars and may ultimately cut more than six years off the life of your 30-year fixed mortgage loan. By dividing your monthly payments in half and paying that amount every other week, you would make 26 payments per year, or the equivalent of 13 full mortgage payments, rather than 12 full payments on a monthly schedule. This extra payment will cost you more each year, but by applying these payments to your principal you will essentially reduce the number of years you will owe on your mortgage and reduce your interest.
For example, let’s say you owe $200,000 on your 30-year fixed mortgage at a 7 percent interest rate. By implementing a biweekly mortgage payment plan, you would save more than $65,000 dollars in interest. If your mortgage was $400,000, you would save roughly $13 1,000. In addition, by paying an extra monthly payment per year, you would shave six years off your mortgage loan.
Paying off your mortgage early also has an immeasurable non-financial benefit, peace-ofmind. Nobody enjoys the burden and persistent financial obligation of mortgage payments. Paying off your mortgage early would leave you with a great feeling of accomplishment and security. This can be a bigger weight off your shoulders if you are close to retirement.
Accelerated mortgage payment plan
An easy alternative to setting up a biweekly plan is to increase the amount of your monthly payments. For example, you can take one additional monthly payment, divide it by 12, and slightly increase each of your current monthly payments. For example, if your mortgage is $ 1,000 per month, you could simply pay $1,083.33 per month instead. This would add up to an extra monthly payment each year. It also gives you the freedom to return back to your regular payment schedule, if you lose your job or become ill.
If you set up your own accelerated payment plan, be sure to instruct your bank to apply these payments to the principal of your loan. Otherwise, they could consider the payment an early payment and apply it to the interest of the loan. You also should check with your bank or loan officer to confirm that there are no prepayment penalties associated with your loan.
If you have the cash flow to pay off your mortgage early, you should first consider other investment strategies. For example, make sure you are sufficiently funding other important financial goals, such as your retirement savings accounts or your child’s college funds. Let’s say you earmarked an additional $1,000 a year for 24 years into a well-diversified mutual fund, 529 college savings plan or your 401(k). At a 7.5-percent growth rate, your $24,000 investment would be worth $67,000. This would be a significant amount of money toward your retirement or college savings plan. This illustration is hypothetical and is not meant to represent any specific investment or to imply any guaranteed rate of return.
Don’t forget emergency savings
Before you commit to paying off your mortgage early, make sure you also have significant savings stashed away in a money market account for a rainy day or an unexpected emergency. If prepaying your mortgage means you are diverting funds away from or forgetting to contribute to an emergency savings plan, you will be putting your financial security at risk. It is recommended that most financial plans include emergency cash savings of at least three to six months’ worth of expenses.
Pay off high-interest debt first
Do not consider prepaying your mortgage if you are in debt. A good rule of thumb is to pay off all your debt first, starting with the highest interest rate. Consider taking out a home equity line of credit (HELOC) to pay off your high-interest-rate debt at lower rates. Interest rates on HELOCs are generally tax-deductible.
Get financial advice
When considering paying off your mortgage early, you also should note that you would lose some tax benefits that mortgages provide. Seek professional help from a qualified financial advisor to create or update your comprehensive financial plan and help you decide if paying off your mortgage early is right for you.
(Dan W. Panzer is an investment representative with American Express Financial Advisors in Albert Lea.)