Revisiting a Perennial Problem: How to Pay Off Your Mortgage
Balance Faster Without Being Scammed
The 30-year fixed-rate mortgage is a great instrument that
has made home ownership possible for millions of consumers,
but none of them like the idea of being in debt for 30
years. Those who like it the least and have the poorest
understanding of how mortgage amortization works are
vulnerable to payoff scamsters, who keep popping up with
alleged easy ways to pay down the balance faster.
It has been a while since I last wrote about these schemes,
but some recent developments provoke me to do it now. Within
recent weeks, the Consumer Financial Protection Bureau
(CFPB) has taken legal action against Nationwide Biweekly
Administration “for luring consumers with false promises of
mortgage savings.” And Wells Fargo, the largest mortgage
lender in the country, has rolled out a weekly payment
program that deserves careful scrutiny.
The Basic Arithmetic of Mortgage Repayment
The basic arithmetic of mortgage repayment is not rocket
science, and if you understand it, you will be invulnerable
to deception. Lets assume you have a 30-year mortgage on
which the current balance (the amount you owe) is $100,000,
the interest rate is 4%, and the monthly payment due July 1
is $477.42. The interest portion of the payment is
100,000x.04/12 or $333.33. When the lender receives your
payment, he takes that amount as his interest earnings, and
the $144.09 that remains, called the “principal”, is used to
reduce your balance. After 359 more payments of $477.42, the
balance hits zero. That’s why it is called a “fully
amortizing mortgage”.
There are only two ways to speed up the process. The main
way is to increase the monthly payment. For example, if you
raise your monthly payment by $100 to $577.42, your balance
will hit zero in month 259 instead of month 360.
The second way to speed up the process is to have the lender
credit your payment earlier, though the savings from this
source are small. For example, if the payment due July 1 is
credited to your account on June 1, you will save the
interest on the principal payment of $144.09 during June,
amounting to $0.48.
Large savings require larger payments. The trick is to find
a pattern of extra payments that you can live with.
Calculator 2a on my web site allows
you to experiment with different combinations of payments,
payment intervals and payment periods, and see the impact on
the amortization schedule, payoff date and total interest
paid.
The Biweekly Mortgage
By far the most common scheme for speeding up the payoff
process is the biweekly mortgage, where the borrower makes
half the monthly payment every two weeks. Since there are 26
biweekly periods in a year, borrowers who do this are making
the equivalent of one extra monthly payment every year. If
the mortgage described above was put on a biweekly basis at
the start, it would pay off in 312 months and save $10,736
in interest. These numbers come from calculator 2b on my
site. This calculator assumes that the lender credits
payments monthly. If the lender credits payments every two
weeks, adding earlier credits to increased payments, payoff
occurs in the 310th month and interest savings
amount to $11,276. These numbers come from my calculator
2bi.
Borrowers don’t need any help in setting up a biweekly
payment plan. All they have to do is set up a special bank
account into which they make their half-payments every two
weeks, and out of which they make their monthly payments to
the lender when due. If they want to avoid the extra step
each month, they can instead increase their regular monthly
payment by 1/12. The results will be almost identical to
those using a biweekly.
Don’t Pay a Biweekly Enabler
Paying a
third party to receive the biweekly payments and pass on the
monthly payment to the lender, is not smart because the
third party will walk away with most of the interest
savings. This is the claim made recently by the Consumer
Financial Protection Bureau (CFPB) against Nationwide
Biweekly Administration, Inc. According to CFPB, the setup
and processing fees charged by Nationwide ate up most or all
of the interest savings earned by many borrowers who
participate in their program.
Wells Fargo’s
Weekly Payment Plan
When
I last looked at weekly payment plans a few years ago, they
offered nothing to the borrower except the convenience of
paying weekly, for which they were charged a small fee. A
new plan by Wells Fargo is more attractive because, in
addition to the convenience of weekly payments, it adds a
payment increase similar to that on a biweekly, and there
are no fees. The fully amortizing monthly payment divided by
4 is paid weekly, which results in four additional weekly
payments (equivalent to one additional monthly payment) a
year. The 4 additional payments are credited to the balance
at staggered weekly intervals throughout the year. The
result is the same as the accelerated reduction in the
balance that results from adding 1/12 of the monthly payment
to the payment every month. Of course, to use this program
your mortgage must be serviced by Wells Fargo.
Can You Roll
Your Own Weekly Payment Plan?
You can, but
it would be a hassle. You would pay one fourth of your
monthly payment into a bank account every week, withdrawing
the scheduled monthly payment within the first 10 days of
each month, and adding the four additional weekly payments
to your monthly payment when doing so will not leave you
short on your next monthly payment. Increasing the size of
your monthly payment by 1/12 is a lot easier.