Tuesday, April 20, 2010

Bi-Weekly Mortgage Acceleration vs. 30 Year Mortgage

For more mortgage comparisons, also read:

In the following example, twin brothers Larry and Louie both purchased identical homes, with the same original mortgage amounts, through the same mortgage company, on the same day. However, Louie decided to immediately sign up for a “Bi-Weekly” mortgage acceleration program. It only cost him a one-time set-up fee of $300 and an additional $6/month service charge.

All Louie would need to do is simply pay half of his original $2,000 per month Mortgage payment every two weeks. In other words, rather than paying $2,000 each month -- he would only pay $1,000 every two weeks until the mortgage was paid off.

Louie was told the benefits of a “Bi-Weekly” acceleration program would allow him to pay off his home more than five years early -- and save him over $81,000.00 in interest payments. WOW!

Larry, on the other hand, decided to get a Standard 30 Year Mortgage with a fixed interest rate of 6% and a monthly payment of $2000.00 for principle and interest. Notice that after 24.54 years, Larry will still owe $110,747.00 on his mortgage. (This fact is important a little bit later.)

Louie, by paying $1000.00 every two weeks, is actually paying $2166.67 a month. This extra $166.67 per month accelerates the payoff of his mortgage by 5.46 years, so his house is completely paid off in 24.54 years! In this example, Louie saves $81,960 in interest, as compared to his brother Larry. Since Louie is used to paying $2166.67 a month, he continues to pay that amount for the remaining 5.46 years, but as an investment in mutual funds.

Larry had the same financial resources as his brother Louie, so he decided he would spend the same amount per month as Louie. Larry paid $2000.00 for his mortgage and invested the extra $166.67 per month into a Roth IRA. By saving that extra amount per month, and assuming a 12% return on investment, Larry had already accumulated $298,475.76 at the time that Louie had paid off his house. So, technically Larry could have paid off the $110.745.00 (see, I told you this would be important later) that he still owed on his house at the 24.54 year mark and still had $187,722.00 left in his investment, whereas Louie had no money invested at this point. Larry decided to keep paying the mortgage and investing the difference and at the end of the 30 years he had accumulated $588,330.73 of Tax-Free money!

The choice to accelerate the mortgage by making Bi-Weekly payments instead of choosing a standard 30 year mortgage actually cost Louie $387.163.18!

Summary of Facts:
  • Louie’s home is paid off 5.46 years earlier than Larry
  • Louie saved $81,960.00 in interest
  • Bi-Weekly mortgage payments means you will make one additional “Standard Monthly” payment per year, therefore, even though Louie only pays only $1000.00 every two weeks, over the course of the year, he actually pays the equivalent monthly payment of $2166.67. This is $166.67 more than Larry pays per month at $2000.00
  • In both examples $2166.67 is invested per month:
    • Larry: With the standard mortgage payments, $2000.00 per month goes to the mortgage for 30 years, and $166.67 per month for 30 years is invested in mutual funds with an IRA tag.
    • Louie: With bi-weekly mortgage payments, $1000.00 every two weeks (or $2166.67 per month) goes to the mortgage and nothing goes to savings for 24.54 years. Then the full $2,166.67 goes to savings for only 5.46 years
  • Larry – investing $166.67 per month for 30 years @ 12% earns $588,330.73 of tax-free Roth IRA money
  • Louie – investing $2166.67 per month for 5.46 years @ 12% earns $201,167.55. (An interesting note is that the majority of Louie’s money cannot be sheltered tax-free in a Roth IRA because it exceeds the yearly maximum.)
  • The cost to Louie for choosing the Bi-Weekly Mortgage as opposed to the Standard Mortgage and investing the difference is $387.163.18
In closing, a mortgage with a low interest rate is relatively "cheap money". If you have extra money to pay on your mortgage, consider either paying off debts with greater interest rates than your mortgage or investing that money in a vehicle (mutual funds with a Roth IRA tag would be wise) that will have a rate of return that is greater than the interest rate on your mortgage. And, never pay someone to set up mortgage acceleration for you. You can actually do this yourself. Just make sure that any extra money you pay to your mortgage is paid to the principal.

I'm so excited to share this information with you. If you have enjoyed the information or feel that it would benefit someone else, please share it. If you have any questions or comments, please feel free to contact me.
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