I recently received an offer from BankOne. It offered me an “almost” free service since I’m a so-called “preferred” customer.
The BankOne Early Mortgage Pay-Off Plan (EMPP) is a bi-weekly mortgage program that allows you to pay your mortgage every other week. That means 26 bi-weekly payments, or a 13th monthly payment.
When you make the equivalent of a 13th monthly mortgage payment, something interesting happens. If you do it regularly, starting from the first year of a 30-year fixed rate loan, you cut the length of the loan from 30 years to 22 years.
In other words, you shave off 8 years worth of interest, which is a fairly significant amount of change. On a $100,000 loan at 8 percent, you’ll pay approximately $733 per month. If you make a thirteenth $733 payment per year, you’ll pay an extra $15,393 over the life of your loan. But you may save as much as $51,330 in interest.
That’s a nice return on your investment. But it gets better. If you pay an extra $100 per month on your 30-year loan, or an extra $1,200 per year, you’ll shave a total of 9 years of interest off your loan, or a savings of nearly $60,000.
If you add $200 to your monthly mortgage payment, you’ll cut your 30-year loan in half, to 15-years. Instead of paying a total of $164,160 in interest over the life of your loan, you’ll pay just $72,017, a savings of $92,143.
If these additional payments seem doable on your income, consider what a 15-year mortgage will do for your bankbook.
With a 15-year mortgage, you’re essentially prepaying your loan enough to cut a 30-year loan to 15 years. The one huge benefit, is that typically 15-year loans carry a lower interest rate than 30-year fixed rate loans. So you’re paying less interest the entire time.
For example, if 30-year fixed rate loans average 8 percent, a 15-year loan might be 7.75 percent, or even 7.5 percent.
On a 15-year loan, at 7.75 percent, you’ll pay $941 per month and only $69,429 in interest over the life of the loan. That’s a savings of another $2,500 in interest just because you’ve lowered the interest on the loan.
There’s no question that prepaying your loan can provide you with a tremendous return on your investment. The question is why would you pay anyone to prepay it for you when you can do it yourself?
Most bi-weekly loan programs charge you anywhere from $250 to $440 to set up the program. For this fee, they then collect your money twice a month and send it in to your mortgage company. In addition to your fee, they collect interest on your money while they hold it for payment, also known as the “float” in investment terms.
To make it even easier on your, and to give them more control over your money, bi-weekly loan programs typically offer to withdraw your cash electronically out of your account.
The BankOne bi-weekly mortgage doesn’t charge you an upfront fee. However, they do charge you $1.25 as an electronic drafting fee for each draft debited from your checking or savings account. Since you’ll be making the equivalent of 26 mortgage payments, or a thirteenth payment, you’ll pay $16.25 to the bank over the course of the year.
That does sound like much. And perhaps, after figuring in the cost of postage (33 cents per payment, or $4.29 per year), the difference between you doing it and the bank doing it isn’t much, just $8 per year or about a nice lunch out.
But the point is, you don’t have to pay anything extra to achieve absolutely the same benefits. And in this case, a dollar saved, and used to prepay your mortgage, is about $1.50 earned.