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.

No Comments

  • By Nate, June 11, 2009 @ 9:48 am

    This is great! I was thinking the same thing myself as I read over that post. I used to read ‘I will teach you to be rich’ often but it has gotten so crassly commercial and less practical and helpful. Personally, I think someone with a 6% or less mortgage has no business paying it down early. I get that it gives them the happy flutters in their heart to feel like they are saving money but there are so many other good things to do with that money. Ex. Put it in a Roth IRA and not only does it grow, but you get the added benefit of tax free growth. I would like to see you do some sort of hypothetical calculation to see what the opportunity cost is for paying down your mortgage vs. investing in a tax advantaged financial instrument. Love your blog, keep them honest!

  • By Kevin M, June 11, 2009 @ 9:58 am

    I think Ramit got a little lazy with this guest post and didn’t check the math or other details. At least most of the comments did question the guest writer, so it appears the catchy headline didn’t fool everyone.

  • By Dan, June 11, 2009 @ 10:46 am

    Take 1/12 of your house payment each month and put it a money market account, then at year end make an extra principal only payment to your mortgage company. Rocket science it is not.

    There is certainly an opportunity cost in paying down your mortgage early and not investing with that money. But that assumes that the decision to do so is purely based on trying to make/save the most money, and that’s not necessarily the only consideration. I’ve paid down auto debt early when I could have made more money investing because I wanted the extra flexibility in my monthly budget.

    All of that said, I’m not a huge fan of I Will Teach You to be Rich. I think it’s mostly an arrogant guy talking down to people about things that are pretty common sense.

  • By Rob Bennett, June 11, 2009 @ 10:51 am

    My comment has nothing to do with the blog entry above except that it relates to the I Will Teach You To Be Rich blog community (which I only discovered just the other day).

    I was posting at the Free Money Finance blog last week re my favorite topic — the futility of Passive Investing. The fellow who is the moderator at the discussion board associated with the I Will Teach You To Be Rich blog suggested that we move the discussion to the forum. I thought that was a good idea, so I started this thread there:

    http://www.iwillteachyoutoberich.com/forums/viewtopic.php?f=5&t=1192&sid=37ea375e6d85dce4c44690f82315a069

    I wrote it as hard-edged as anything I have written. I said everything but that following the Passive model is going to cause your dog to run out into the street and get hit by a car. And no reaction!

    That’s never happened before. Is that a good sign or a bad sign?

    I think it’s a good sign.

    Please don’t respond to this mostly-off-topic comment. I report it here just because I am trying to figure out what this unusual reaction means and there might be one or two here interested in how the neverending tour is going to play out. It could be just that there are not enough people there for even some strong (but fair, in my view) words to generate a reaction. But I don’t know. This is the first time this has ever happened to me in seven years. So I see Significance.

    Back to your regularly scheduled program….

    Rob

  • By Asa, June 11, 2009 @ 10:59 am

    I agree with your post except for the last sentence: “psychological problems should be treated by psychologists, not worked around by personal finance advisors.” You can’t ignore the psychological aspects of personal finance. It’s not just about saving the most money or getting the best deal. I believe it’s about having a fuller life and making dealing with finances less of a burden. Psychological issues cause a lot of people to not even begin dealing with their financial issues. I’ve heard so many people say things like “I don’t even know where to begin” or “It’s too complicated to invest myself”. Those are real issues with psychological components that I think financial advisors should respond to.

  • By Frank Curmudgeon, June 11, 2009 @ 11:26 am

    Asa: I agree that psychological issues should not be ignored. But I think this is exactly what many givers of advice on personal finance do. Instead of saying to their audience “Look, this is irrational and self-destructive behavoir, you need to change.” they either shrug their shoulders, saying that the behavoir is a universal and unfixable part of the human condition or just lie and give bad advice as a work-around. (For example, Orman’s crazy assertion that you should never take out a loan from your 401k, even to pay off credit card debt. That only makes sense if you assume, as I infer Orman does, that the consumer will soon run up the credit cards again and then owe twice as much.)

    That a third of BofA mortgage borrowers are willing to pay money to get billed more often because they do not believe that they are able to make larger monthly payments on their own speaks to a larger issue that is just being ignored by the gurus.

  • By Steve, June 11, 2009 @ 12:13 pm

    I am quite dubious about the 33% number. I would be *extremely* surprised if that high a percentage are even vaguely interested in paying off their mortgage early, using any means.

  • By m, June 11, 2009 @ 1:00 pm

    I find that since Ramit published, the quality of the blog has gone way down. That said, I am a responsible 20 something and I’m paying extra on my mortgage (b/c I can) the old fashioned way: by using my brain! There is no end to what people will try to charge money for these days. Frank, good for you for being a source of *real* common sense around here.

  • By ryan, June 11, 2009 @ 1:49 pm

    I make double mortgage payments on a 30 year, 5.5% fixed. It’s a form of investment diversification. Specifically, this will ensure that no matter what the stock market does for the next 10-20 years, I’ll have no mortgage when my kids are in college.

  • By SJ, June 11, 2009 @ 1:53 pm

    Hahahaha… Math

    That’s all I can really say…

  • By yogijudy, June 11, 2009 @ 1:58 pm

    Thank you, thank you, thank you! I read the post on I Will Teach You to Get Rich and actually called my mortgage holder to see about signing up. I was subjected to a loooong sales pitch and realized right away that there was no way I was going to pay to do something that I could easily do myself (i.e. make an extra payment or apply extra $ to the principal.) When I made that point to the salesperson, she said that “it gets complicated” when you do it on your own and sometimes the money isn’t applied where you want it. Ridiculous!

    That post was the cause of a lot of my time wasted. Shame on Ramit!

  • By Patrick, June 11, 2009 @ 3:37 pm

    The difference between $2600 and $1200 is clearly because you took it as $4 per month and they took it as $4 per biweekly payment.

  • By Frank Curmudgeon, June 11, 2009 @ 5:00 pm

    Patrick: Aha! 4 x 26 x 25 = $2600. I guess I misunderstood what the post meant by “they charge a $4 fee every month.” Silly me.

  • By IndependentOperator, June 11, 2009 @ 5:13 pm

    “psychological problems should be treated by psychologists, not worked around by personal finance advisors”

    Brilliant!

  • By Jim, June 11, 2009 @ 6:19 pm

    Those bi-weekly plans also usually charge you a $200-300 setup fee to set them up. :(

  • By Matt, June 11, 2009 @ 8:17 pm

    I once worked for a guy who paid all of his bills (cable, utilities, credit cards, etc.) with loose approximations of half or a third of what he owed. He used online BillPay and just sent Comcast $25 three times per month. If the bill was actually $85, he’d get late fees and a shut-off notice – basically because he was too lazy to open the mail and pay accordingly.

    His “reasoning” was a monthly pay cycle. As far as I saw (about 18 months of records) his “system” failed repeatedly – by splitting a simple bill into three payments, he tripled his chances of forgetting.

  • By Kosmo @ The Casual Observer, June 12, 2009 @ 12:52 am

    This doesn’t sound like an actual BAD idea until you take into account the additional fee. Yikes. We just pay a bit more every month. We just set up the automated paymen for a higher amount.

    As for B of A’s numbers … it’s Bank of America, so I wouldn’t trust the numbers. BoA might not be lying, they might just be clueless. I’m not a big fan. (Why, you ask? -> http://www.observingcasually.com/the-29-fee-that-cost-bank-of-america-so-much-more/ )

    Matt – wow. Sounds like your former boss had a “great” system. Did he pay the employees the same way?

  • By GPR, June 12, 2009 @ 10:50 am

    I worked as a journalist long enough to make a guess at that 33% number: the writer asked someone at the Bank who said “oh gosh, I don’t know, maybe a third?” This was dutifully transcribed as 33%. Sounds more precise, dontcha know.

  • By Rick Francis, June 12, 2009 @ 12:47 pm

    I agree with GPR that the 33% number is too neat to be realistic and Steve that it seems too high a percentage. The only way it could be right is if BOA had a lot of sales people pushing the option and ~1/3 of people with mortgages can’t do math!

    I made extra payments on my mortgage when it was at 6.75%, but I did it by just paying a bit extra each month for free! The steps were simply:
    #1 Write the check for a bit more
    #2 Write additional amount in the line for additional principle payment
    What is so hard about that?
    A bit over a year ago I refinanced to a 5%, 15 year mortgage and kept the payments about the same. I haven’t made additional payments since. I’m confident I can beat 5% returns, and I’m building up equity fast enough. Instead, I’ve increased my retirement contributions.

    -Rick Francis

  • By GPR, June 12, 2009 @ 2:39 pm

    “psychological problems should be treated by psychologists, not worked around by personal finance advisors”

    Do you define “psychological problem” as “letting our emotions get in the way of rational behavior?”

    Because that’s basically the root human condition isn’t it? Falling in love with the wrong person. Buying Axe Body Spray. If we didn’t do irrational things, well, Spock would be a boring character. And advertising wouldn’t work. And financial blogs would be really short.

  • By MyFinancialIndependenceCoach.com, June 12, 2009 @ 5:57 pm

    I love the fact you are as disgusted with this simplistic advice as I am. Having owned a mortgage and helped families for 11 years now on understanding how mortgages and real estate work, here are a couple of thoughts:
    1. I always explain the same thing…you can pay the loan down faster, for FREE, on your own.

    2. Deciding to pay down your mortgage or invest absolutely does depend on what “else” you do with the money. What I’ll add is homeowners just have to understand the true, after-tax cost of their mortgage. If your interest rate is 6.0%, most families don’t realize this is NOT what you are saving when you pay an extra $100 towards the mortgage. If you are deducting the mortgage interest each year on your taxes, the true cost of this mortgage is not 6.0%.
    Take 6.0% x (marginal tax bracket)…say 30% to be easy. This equals 1.8% “tax discount” from Uncle Sam. Now, take your 6.0% mortgage rate minus 1.8% “help” from the government…and your “EPR” (Effective Percentage Rate as we teach our online coaching members) = 4.2%.
    THIS is the number to compare with what you might earn elsewhere if you invest the money.

    Add to this, the fact that liquidity is the most important thing possible. I’m now coaching so many clients who called me upon losing their job…and they NOW realize how nice it would have been had they NOT sent BofA, or Wells Fargo, or whoever, all those extra mortgage payments.
    Saving interest is fantastic…but it’s like any other investing decision – Liquidity, Safety, and Rate of Return. Home Equity fails miserably on the liquidity portion, and unfortunately, in a dire economic state as we’re in now, too many families are just now learning the power of having the money in their hands, and not the bank’s.

    Hope that helps someone out there! Great article…

  • By Neil, June 29, 2009 @ 6:56 pm

    Huh? Pay extra for biweekly? That seems dumb. My bank certainly doesn’t have such a policy. I personally like the biweekly because it does line up with my paychecks, and in the real world, there’s a good chance I’d just buy small things I don’t really need with a good chunk of the money saved.

    In practice, I’ve found that my savings rate has stayed pretty constant as my income has risen, so it seems unlikely that freeing up an extra $1400 per year would actually generate any opportunity worth writing home about. Different people may have different results.

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  • By Paul Williams, May 28, 2012 @ 11:43 pm

    @MyFinancialIndependenceCoach: Actually, the true after tax rate to compare would be a little bit higher because of the standard deduction. The only tax savings you’re really getting from the interest comes from the amount by which it exceeds the standard deduction.

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