Apparently there was a recent article on Yahoo Finance about Bi-Weekly Mortgages and how great they are. In the comments section somebody called my website out and saying that as a mortgage guy I want you to be in a 30 year mortgage because I get the interest each month for 30 years. Well folks this person doesn't know much about how mortgage lenders are paid. I get paid for doing a loan I don't get any residual income from interest that goes to the end investor usually on Wall Street that funded the loan through a mortgage backed security. There was another visitor to my site that was too afraid to give me their name or to engage in intellectual discourse on the subject they instead just called me an idiot and said I was giving bad advice.
Well if you read the information on my site I think that you will find I try to back up everything I publish with numbers, strategies, and conservative estimates. Well that's what I am going to do now.
The only way that a bi-weekly mortgage will save you the thousands and thousands of dollars that they claim you would have to keep your mortgage for the full time it takes you to pay off the mortgage. Don't get me wrong a bi-weekly mortgage does save you some money even if you don't keep the loan, but the numbers aren't nearly as impressive.
Using facts about human behavior in regards to how long we really keep a mortgage we have created a comparison that we will share here. First, according to Fannie Mae (Federal National Mortgage Corporation) the largest purchaser of mortgages said that 80% of all their mortgages are paid off within 5 years. Of course this is mostly through selling and refinancing though a few could truly paid off by writing a check for the balance. They go on to say that 90% of all loans are paid off in 7 years and 99% within 12 years.
To put this in layman's terms if you were going to the casino and going to play roulette and there was an 80% chance of black and a 20% chance of red which would you bet? Black right? Well for all those of you that get fixed rate mortgages and do bi-weekly, or extra principal payments or 15 year mortgages are betting RED! See there is an 80% chance you will pay your loan off within 5 years so getting a lower rate 5 Year ARM (in normal markets) is the product of choice for those of you that follow actual behaviors and not the behaviors of your parents and grandparents.
Ok, back to the comparison. I took a $200,000 30 year fixed rate loan at 6.5% that has a principal and interest payment of $1,264.14. The bi-weekly payment would come out to a monthly equivalent of $1,369.48 or $105.34 per month more. If you actually kept the mortgage until it was paid off it would take 24 years and 2 months and would save you a total of $57,941.20 (the difference between 360 payments at $1,264.14 = $455,090.40 and 290 payments of $1,369.48 = $397,149.20).
The problem with this math is there is less than a 1% chance you will have the loan for 290 months. So let's look at the difference at 60 months (5 years), 84 months (7 years) and 144 months (12 years).
At 60 months the total difference between the amount paid and the lower balance on the mortgage is a whopping $1,124.45(that's $224.89 per year). If you go out 7 years the savings is $2,318.99 ($331.28 per year) and if you go out 12 years the savings is $7,718.72 ($643.23 per year). Don't get me wrong that is savings, but certainly not the huge savings that these programs espouse. Especially if you pay their upfront fee and many have a $3 to $7 fee every time you make your bi-weekly payment- that could be 26 payments * $7 or $182 thus the savings is now $42.89 per year.
Okay, if you have read any of the posts on my regular blog (www.kcmortgageplanning.com/blog) or other material on my site you know that I am always going to take a look at the possibility of redirecting that monthly payment difference into an investment earning a CONSERVATIVE return. In this comparison let's assume an after tax annual return of 6%.
So if we took that $105.34 difference in payment (between 30 year fixed and the bi-weekly equivalent) and invested it earning 6% in 5 years the amount in the investment account is actually $1,029.22 MORE than the savings from the bi-weekly payments. In 7 years it is $2,114.68 more and in 12 years it is $6,968.57 more.
So what I am saying is that the amount in the investment account would pay down the balance of the mortgage to where it was with the bi-weekly payment AND have $1,029.22, $2,114.68 or $6,968.57 MORE IN CASH! I have this information in an excel spreadsheet that if you want you can email me at kurt@kcmortgageplanning.com and I'll send you a .pdf of it.
The investment account balance at 5 years is $7,349.90, 7 years $10,963.63 and 12 years $22,138.20- so friends that is cash you would have available to you if something bad happened like a job loss, disability, death of a spouse, divorce, etc. See the things that would cause you to NEED cash are largely the same reasons to keep you from being able to access the wealth you store inside your house in the form of equity.
Another thing to keep in mind is I didn't even use the additional tax advantages of keeping your mortgage balance higher, if I had it would skew the numbers even further against bi-weekly payments.
So let's recap here. The mortgage rate is 6.5% and the estimated rate on the investment is only 6% how can that come out ahead? That's the big differentiator and why these types of plans can beat ANY principal reduction plan - it's the power of compounding interest. See when you have money in an investment you have your principal amount that earns interest and if you leave that interest earnings in the investment then it grows on that bigger amount and so on and so on. Where your mortgage is a simple interest balance so there is no compounding. It's no wonder that Einstein was rumored to have said that "compounding interest is the most powerful force in the world."
I guess when I look at things differently I am just an IDIOT. To borrow lyrics to an old song, "If being an IDIOT is wrong I don't want to be right!"
Is your mortgage provider giving you this type of in depth analysis, research and mortgage planning? Shouldn't they? That's what we are here for, if you don't mind working with an IDIOT.
Until next time.
Kurt
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