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Biweekly Mortgage Conversion

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Summary:

This article discusses the pros and cons of taking your current mortgage and converting it to a biweekly mortgage.
Mortgage payments are due once a month. However, many people are paid every two weeks--biweekly. The original idea of a biweekly mortgage was to synchronize the mortgage payments with this schedule.
One of the results of this approach is that you can pay off your mortgage sooner. This is true regardless of whether you happen to be paid biweekly. It is because there are 26 biweekly periods in a year, so that if you make half a mortgage payment biweekly, it is like making 13 mortgage payments instead of 12. This can shorten your mortgage term dramatically, from 30 years to about 20 years (the exact number varies depending on your interest rate).
Even if you do not have a biweekly mortgage, you can convert your mortgage to a biweekly payment scheme. You can arrange to send half your mortgage payment every two weeks to a third party, who then will make your regular mortgage payment plus the additional payments that the biweekly schedule facilitates. In theory, you can make principal payments yourself any time you want without the help of a third party. However, few people have the organization and discipline to execute a biweekly payment plan on their own.
To evaluate biweekly mortgage conversion in your situation, ask yourself these questions, which are discussed in detail below.
  • Is the provider reputable?
  • Does the provider hold the money for an unreasonably long period?
  • How do you calculate the benefits?

Is the provider reputable?

A few years ago, biweekly conversion was offered by fly-by-night companies. The reason is that if a company were to deduct money from your bank account and then not pay your mortgage payment, you could suffer a loss.
If a well-known bank handles your biweekly conversion, the concern about losing your money does not apply. A bank is not going to stain its reputation by reneging on its promise to forward your money to the mortgage company.

How long does the provider hold your money?

With a biweekly mortgage, there is a period of time between when the converter takes money from your account and when it pays the mortgage. During this time, you lose the interest you otherwise would earn on this money. Usually, this is small, but some converting companies hold part of your payment for the entire year before making the "extra" payment, and that can increase the cost. Before you sign up for a biweekly, make sure that the payment schedule is explained to you. You want to avoid having a gap of several months between the time money is taken out of your account and the time that money is paid in to your mortgage.

How do you calculate the benefits?

Do not confuse converting to a biweekly mortgage with refinancing your mortgage at a lower interest rate. When you refinance at a lower rate, you pay less money to the mortgage company and have more of your income left over to use at your discretion. With biweekly conversion, you pay more of your money to the mortgage company and have less of your income left over to use at your discretion.
If you undertake the type of analysis taught in finance courses in business school, the benefits of paying off your mortgage early using a biweekly schedule will not seem terribly large. If your monthly payment is $1,000, then with a biweekly plan you will be making one additional payment of $1,000 per year on your mortgage. A finance professor would ask, "What is the return on this $1,000 investment, taking into account the opportunity cost of the next best investment?" If your mortgage rate is at 7 percent, and you can invest your money elsewhere and earn 5 percent, then the difference is 2 percent. Multiplying 2 percent times $1,000 implies a benefit of $20 per year.
While business-school professors and major financial institutions use the opportunity cost of funds to evaluate their investments, ordinary individuals may not feel that this concept applies to their way of budgeting. You might decide that the discipline of the biweekly mortgage can enable you to save income that otherwise would be frittered away. If so, then for you the benefits could turn out to be a thousand dollars a year or more.
In conclusion, the benefits of a biweekly mortgage vary according to the individual. Do not accept at face value a hard sell for biweekly conversion without evaluating your own situation and doing your own analysis.
 
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