Mortgages cost too much so instead of the usual 30-year deal why not go for biweekly financing? The math says such programs work. Unfortunately, for many borrowers, reality says they don’t.
How can that be? Let’s start with the math part.
Imagine that Smith borrows $200,000 at 4 percent over 30 years. The monthly cost for principal and interest is $954.84.
With a biweekly loan the numbers look like this:
Half of $954.84 is $477.42
If Smith makes a payment of $477.42 every two weeks he will make 26 payments per year (52 weeks divided by 2 = 26).
According to The Mortgage Professor’s biweekly mortgage calculator, the interest cost will be reduced by $22,552 and the loan term will be cut by more than four years.
What’s really happening here is not especially amazing.
The way the 30-year loan was originally set up there were 12 payments of $954.84 or $11,458 per year. The biweekly payment is $477.42 and that’s just half of the regular payment. However, because there are 26 biweekly payments the borrower is actually paying $12,413 per year.
The secret of biweekly mortgages is that the borrower is paying more to the lender each year. Twenty-six biweekly payments are the equivalent of 13 monthly payments.
Since biweekly mortgage math is correct why is it that people do not use such financing more frequently?
There are four basic answers.
First, in a tight economy many borrowers are unable to make the additional payments.
Second, mortgage servicers, the people who collect payments for lenders, generally will not accept biweekly payments. The thinking seems to be that it’s hard enough to keep track of 12 payments per year, 26 payments just creates an another layer of complexity, and more payments equal more costs for the servicer.
Third, biweekly loan products have been and are still directly available through lenders. For instance, starting in 1988 Fannie Mae bought conforming biweekly mortgages from local lenders but dumped the program in 2009 citing “a lack of demand and increased operational costs.” However, Freddie Mac has a different approach — since 2009 it has told lenders that it will buy conforming biweekly loans but only on a negotiated basis. Speak with lenders for details.
If a lender offers a biweekly program all the usual questions apply: Can you convert back to monthly payments? Is there a conversion fee? Are there any extra charges to participate in the biweekly program? What about the interest rate and points? How much faster will the loan be repaid? Can you simply have a regular loan and make extra principal payments without penalty or additional cost?
Fourth, if you look at today’s mortgage payment coupons they typically have an option which allows borrowers to make extra principal payments. This is an invitation from the lender to prepay the loan.
In the case of FHA, VA and conforming mortgages — loans which satisfy Fannie Mae and Freddie Mac guidelines — there are no prepayment penalties. The same is true for many private-sector loan products, though not all.
Because loan servicers will generally not accept biweekly payments, a market has emerged for third-party, independent biweekly plans. The way such services often work is that the borrower pays an upfront fee to set up the program and then processing fees with each payment. Once enrolled, the borrower makes biweekly payments to the program manager and in turn the biweekly company makes payments to the actual lender.
Do borrowers benefit with such programs? That’s the logical question which arises from an emerging dispute.
The Consumer Financial Protection Bureau (CFPB) is now suing Nationwide Biweekly Administration, Inc., Loan Payment Administration LLC, and the companies’ owner, “alleging that Nationwide misrepresents the interest savings consumers will achieve through a biweekly mortgage payment program and misleads consumers about the cost of the program.”
The CFPB’s suit also alleges that “the defendants know that consumers will pay more in fees than they save in interest for the first several years in the program.”
In a statement to the HousingWire news service, Nationwide contends that the CFPB action is based on “errors”
Nationwide also told the HousingWire that “even consumers who use our program for only one year will save more over the term of their mortgage than they have paid to our company. Again, if the customer was on the program for only one year and then canceled, they would achieve these savings.”
The CFPB suit raises a broader mortgage question: Do borrowers who refinance know that the cost of a new loan may well be greater than their savings for a given period, perhaps several years? Are lenders responsible for providing such information? How many years are “too” many or somehow deceptive or unfair?
The Biweekly Mortgage Alternative
Mortgage borrowers can get the lower financing costs they want in several ways.
First, shop around. Most borrowers don’t — according to the CFPB 77 percent of all borrowers only apply with one lender.
Second, use that “extra principal” feature on your mortgage coupon to craft your own custom-made prepayment program. You can add as little or as much as you like each month above the required payment depending on your finances at the moment.
Third, to enhance financial discipline establish a monthly budget — and stick to it. Take a portion of the money you save and use if for mortgage prepayments.
Fourth, the benefits of prepayments with adjustable-rate mortgages may be reduced if rates increase and getting a particular result is not certain.
What really makes sense for many borrowers are mortgage prepayments in general, a form of saving. It’s easy to do with that handy, convenient and acceptable “extra principal” option on many if not most mortgage coupons. With the do-it-yourself approach you can build the equivalent of a biweekly mortgage program, a 15-year loan or another term just by upping your monthly payments — and you can do it with the lender’s blessings and without additional fees or charges. The money you save can then go to your real purpose, paying down your mortgage.