Saving $71,000 on Your Mortgage

On Monday a guest post at I Will Teach You To Be Rich disclosed the secret formula to saving $71,000 in mortgage interest payments.

There are things I like about I Will Teach You To Be Rich.  Ramit Sethi, its owner and usual author, is anti-Latte Factor and even more obsessed with VA_house Suze Orman than I am. And he’s often quite funny. But the blog also awfully gimmicky. And the scheme to save on your mortgage is a classic gimmick that’s been knocking around for years now and should probably just be put out to pasture already.

The very specific sounding $71,000 mentioned in the post’s title turns out to be an arbitrary estimate of what you could save in interest, assuming a particular rate and principal amount.  The way you do this is through bi-weekly payments.

If you are unfamiliar with this old chestnut, it works as follows.  Every two weeks you pay half your normal monthly mortgage payment. This is, allegedly, not hard for people to do because they get paychecks on the same cycle. The trick is that half a payment every two weeks is 13 full payments a year, so you are ahead of the game. Eventually, this will pay off your mortgage early, saving you money otherwise spent in interest.

To begin with, this is nothing more than a complicated way to send in an extra mortgage payment every year, which is in turn nothing more than paying down your mortgage a little faster than normal. And paying down your mortgage early may or may not be a good idea, depending on what else you might do with the money.

Besides being arbitrary in the amount, the savings cited by the post is wildly exaggerated because it implicitly assumes that there is no opportunity cost to those extra payments. This might be true if your alternative to making extra payments was to stuff the money in your mattress, but if you had potential investments that had a return that was the same as the mortgage interest rate then your net savings from the scheme would be zero.  (And if those potential investments would have returned more than the mortgage interest this plan will cost you money.)

The $71,000 figure also does not consider inflation, which is a non-trivial issue given that the biweekly scheme will take 25 years to fully play out.

But the icing on the biweekly cake is that this is not something you can just do yourself. Generally, biweekly payments are something that mortgage servicers charge you for. According to the post, Countrywide/Bank of America charges $4 a month to let you pay them more often. (The post also says this works out to be $2600 more over the life of the loan. Huh? $4 x 12 x 25 = $1200)

It’s here that I think this idea goes from not so hot to just plain nuts.  How much would you pay to be able to pay your cell phone bill more often? Perhaps if you offered BofA $8 a month they would allow you to pay weekly. How much do you think they would want for daily?

A person can get precisely the same pre-payment effect by paying an extra 1/12 of a payment each month. For free.

I was reminded why I write this blog when the video portion of the I Will Teach You To Be Rich post cited the "sad fact" that "only 33%" of BofA customers take advantage of this wonderful service. I’m hoping that number is as exaggerated as some other numbers in the post, but in my heart I know better.

Defenders of biweekly plans argue that they are superior to paying a little more on your regular monthly bill because for various psychological reasons paying more 12 times a year is harder than paying 26 times. I am sure that that is true for some people, but psychological problems should be treated by psychologists, not worked around by personal finance advisors.

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