Many lenders offer loan repayment programs that differ from the standard monthly payment arrangement. The inducement is an earlier payoff. These programs can be confusing, and the claims made for them are often exaggerated. The questions below illustrate three alternative payment schemes: bimonthly, biweekly and simple interest biweekly.
There isn't anything wrong with the bimonthly, provided you didn't give up anything to get it. Whoever told you that it would reduce the term of a 30-year loan to 23.5 years was blowing smoke. On a 7% 30-year loan, it takes 718 bimonthly payments, or 29 years, 11 months, to pay off. In other words, you knock just one month off the term.
A bimonthly mortgage involves no extra payments. You make 24 payments a year instead of 12 but they add to the same total. By advancing the payment by half a month, you save a little interest, which means that a slightly larger part of succeeding payments is used to reduce principal.
The effect, however, is small. A standard $100,000 loan at 7% for 30 years would have a balance at the end of year one of $98,984.19. The same loan cast as a bimonthly would have a balance of $98,982.66, or only $1.53 lower. The difference grows over the years, but only by enough to knock one month off the term.
I have been offered a simple interest biweekly mortgage that is said to be much more powerful than conventional biweeklies because the payment is applied to principal right away...I don't understand the difference.
A biweekly mortgage is one on which the borrower every two weeks makes a payment equal to half the monthly payment on a standard mortgage. The payment on a biweekly is thus the same as that on a bimonthly. But since there are 26 biweekly periods in a year compared to 24 bimonthly periods, the biweekly requires the equivalent of one extra monthly payment every year.
This results in a significant shortening of the term. For example, the 7% 30-year loan converted to a biweekly pays off in 287 months - or 23 years, 11 months. The reduction in term is due entirely to the extra payment every year.
On a standard biweekly, the biweekly payments are credited to an account managed by the lender. The lender makes the monthly payment out of the account on the first of the month, just as the borrower would do on a standard mortgage. The interest earnings on the account belong to the lender. When a year has elapsed, the excess amount accumulated in the account is equal to a full payment. It is only at this point that the lender makes a double payment that depletes the account.
The simple interest biweekly differs from a standard biweekly in that the biweekly payment is applied to principal every 2 weeks, rather than held in an account. This results in a faster payoff for the same reason that a bimonthly pays off faster than a standard mortgage. Again, however, the difference is small. Where a 7% 30-year standard biweekly pays off in 287 months, the simple interest version pays off in 284 months.
Borrowers who like the idea of accelerating the payoff need not pay extra for the privilege; they can do it themselves. By making a double-payment once a year, they will pay off just as if they had a standard biweekly. Alternatively, by increasing their monthly payment by 1/12, they will pay off as if they had a simple interest biweekly. The only borrowers who should opt for an alternative payment plan administered by the lender are those without the discipline to stick to a plan of their own.
