Can someone please explain this type of mortgage re-fi plan to me?

General Questions
#1

My stepbrother is starting to work for a mortgage refinancing company soon. He was trying to explain his companies angle, and it wasn’t really getting through too well. He kept talking about bi-weekly payments, and shaving years off one’s loan.

Here’s what I figured out, the rest is not totally clear.

Take a monthly mortgage payment of $1000, over 12 monthly payments one would have paid $12,000. If one paid $500 every two weeks instead (52 weeks in a year, 26 payments), one would have paid $13,000 after one year. In essence, it seems that every year, you would be 1/12th of a year closer to final payoff, and for a 30 year mortgage you would shave 2 years and 2 months off of the total payoff time. To me this seems like just paying off the loan a bit faster. He claimed that it takes 23 years of payments on a 30 year loan in order to get to the halfway point. He also claimed that they could in effect shorten a 30 year loan to a 23 year loan. :dubious:

He kept talking about saving hundreds of dollars per month in interest, and the savings being applied towards the principal. He really didn’t explain this part.

The people he would be pitching this to have at least $40,000 of revolving and some other type of debt combined. They also have a minimum credit score of 640 I think.

He said “If you don’t use the bi-weekly option, you’re retarded” ad nauseum. Not a great sales pitch, I know. I asked him "If your system is the end all ,be all of loans, why on Earth isn’t every single person that qualifies using it? He dodged the answer somewhat.

This all sounded like some sort of scam of some sort to me, but I don’t know. My knowledge of mortgages is almost nothing.

So, what’s the SD on this? Does it make sense for certain people? Is it a scam? How does it work?

#2

His math is correct, assuming the loan has no prepayment penalties, etc. The extra dollars go to reducing the principal, and the lower the principal, the lower the interest.

The question is, if someone already has a mortgage that has no prepayment penalty and wishes to use this sort of a plan, why what do they need your step-brother for? And why would they ever pay someone for this? Just send in the extra dollars with your normal payment every month.

#3

I am not a mortgage broker (thank god)…but I’ve heard about this “angle” before. It is called “paying off your mortgage early”.

If you make larger (or more frequent) payments on your mortgage, you will pay off your mortgage sooner, and will of course pay less money in interest.

This isn’t magic, and you certainly don’t need to refinance in order to get this “special” payment plan.

You simply need to send in a check for half of your mortgage payment every two weeks instead of sending in a check for the full amount once a month…and Shazam you’ve paid down your mortgage a little faster than you had to.

If you are in the market for a refinance…have I got a plan for you…I call it the Weekly Wizard Plan ™. It is twice as good as your brother’s plan because it has twice as many payments!!! All you have to do is make a weekly payment that is one fourth the amount of your normal monthly payment…I can’t go on…

On preview what Lamar said…with less sarcasm.

#4

It’s nothing but an effort to tie making a payment to the fact that most folks get paid every two weeks instead of monthly.
You pay more per year and as a consequence, pay off the note faster. It’s as simple as that.

Is it a good deal?

Well, it’s an OK deal if your goal is to pay off your mortgage faster. With most loans, there is nothing to prevent that anyway; you can usually pay as much extra as you want on the principal without penalty voluntarily, and that does exactly the same thing.

Some folks might want to take out a 30 year fixed note and pay it off as slowly as possible, assuming that the cost of borrowing might rise tremendously over the period they hold the note. In that case, they will make more by investing the money elsewhere that they would otherwise use to pay off the note early.

Other folks might want to take out a 15 year note and pay even more on it, reasoning that the sooner they are out of debt the better off they will be.

Taxes also figure into this, since for most people what you pay in home interest is deductible.

It’s a fine, and old, idea, but whether or not it’s a great idea depends on who you are. Some people like the discipline of having to pay in closer alignment to when their paycheck comes. Generally speaking it’s no different than taking out a note for a shorter term. How good any loan is depends on things like the interest rate and term, borrowing costs and whether or not the rate is variable. It does not depend on how often you make payments.

#5

That’s along the lines of what I was thinking. He didn’t go into any detail about these terms, and I didn’t know or really care, enough to ask any really meaningful questions.

How does one pay off the principal faster without having to pay the interest first? Is it just a matter of paying off the interest faster means that you get to the principal part faster?

#6

On a standard mortgage, each payment is a combination of several things…frequently interest, principle, taxes, and insurance. Each month you are paying off the interest that has accrued during the past month, plus a bit of principal, plus (often) some money to cover your home insurance and taxes that will be due sometime during the year. Once you’ve made your required payment - which covers the interest you’ve accrued so far - anything extra you pay goes straight to the principal. This pays down the loan early…and since you now owe less money you will, over the life of the loan, accrue less (and thus pay less) interest.

Generally speaking you aren’t required to pay for interest that you “might” accrue 30 years from now first, before you can pay down the principal. If anyone ever tries to get you to agree to such a deal…run away.

#7

Each mortgage payment has a portion that goes to Interest and a portion that goes to Principal. Since the Interest portion is calculated off the remaining Principal, paying faster means more of the payment goes to Principal.

In the beginning of a 30 year mortgage, most of the payment is going to Interest. Towards the end, nearly all of it is going to Principal.

#8

As to whether or not the pitch made by the step-brother is a good deal or a “scam” in the OP’s words, I would wager that since this payment plan can be had for free, the substantial costs frequently associated with refinancing would not be justified if this payment plan were the only benefit.

#9

Pretty much came in to confirm what everyone else has been saying.

While all my financial industry experience is in Australia, there are some precepts that hold true all over. This case being one of them.

I find it interesting that paying fortnightly seems such a ‘revelation’ in America, it is a standard way of doing business for all banks, credit unions and misc. financiers here in Australia.

Oh and while I understand your post was sarcastic InLuceMedita I felt the reflex need to clarify, just in case someone reads it and has casue to think on it. [Ugh, can’t resist, must… reveal… secret… bankers info] Paying weekly will save you nominal amounts, at best, over paying fortnightly. As it doesn’t involve making any additional payments, you are only saving 7 days of interest on the amount you paid weekly. (Which is 36 cents a week, based upon a $145k @ 7.55% with mortgage payments of around $1,000 a month *).

And as a rule of thumb, with a typical 30 year loan, your payments are predominately only meeting interest costs for the first 6-7 years, after that time your payments will then tend to be making more of dent into the principal.
*This presumes the average mortgage in the US has interest calculated daily. I presume so but aren’t 100% sure of.

#10

From what I’ve gathered about these “bi-weekly” plans is that they often charge additional “administrative fees” to set you up with such a plan. From what I’ve heard, the same thing can be accomplished by making only ONE additional payment every year.

#11

Great answers BTW!

Why would an over-payment go towards principal if most loans are geared towards paying off the interest first?

I have a feeling that the answer is very simple.

I’m guessing that the interest is based on the loan going full term (sans early payment penalties of course). So, if early payments are made, the interest is adjusted and the overall total is lessened, in a shorter time period as well.

So, is his company basically just qualifying debtors, offering them a payment plan that they may already have available to them, and then reaping all the interest, fees, and whatever else might be applicable?

#12

I’m a lay person, so maybe I will be able to explain it in lay terms.

When you originate a loan, you are given an amortization schedule. Here is a decent amortization calculator. Play around with it a little bit to see how the amount you pay in interest and the amount you pay in principle change over the term of the loan. The payment itself remains constant, it’s the ratio of interest to principle that changes. The interest owed is based on the remaining principle.

The bank collects a mortgage payment (consisting of principle, interest, taxes and insurance) on a monthly basis. That’s what they count on and that’s all they expect of you. If you pay every two weeks, for 10 out of the 12 months you will make the same payment as if you were paying it off normally. In the other 2 months there will be an ‘extra’ payment. Since you’ve already paid the bank for the month, this extra payment goes straight to principle. For your subsequent payments, the ratio of interest to principle is reduced.

Make sense?

#13

And there’s the scam. As mentioned already, you don’t need to sign up for the “bi-weekly” scam (assuming they charge a fee). You can just add to the principal at your leisure anytime. If you want to be on a schedule and knock off that extra $1000 per year as illistrated in the OP, just add ~8% to your monthly payment. On the bill, there’s usually a check-box for “add to principal” and a line for how much you wish to add. If not, a call to your mortgage company will clear things up on how to add extra to the principal along with your normal PITI (also as mentioned, make sure there’s no mortgage pre-payment penalty). Of course, if your mortgage company does offer a bi-weekly plan with no fees and it’s convenient for you, there’s nothing wrong with that either. Just watch out for the fees. The fact that the mortgage company hires someone specifically to tout the program, means they’re likely charging a fee. It’s just another way to exploit what can already be done for free by those who don’t pay attention to the fine print and will pay for it. Not always, but I’d be cautious.

#14

Here’s an explanation from Bankrate: http://www.bankrate.com/brm/news/DrDon/20070103_biweekly_bimonthly_payment_a1.asp

#15

Just to add a bit, and to throw in some sample numbers, in a mortgage you may have $1000/month payment (ignoring insurance and escrow), in the beginning you may be paying $950 in interest and $50 principal, at the end of the loan you may be paying $50 interest and $950 in principal (somewhere in the middle you may be paying $500 on each). The reason is at the beginning you owe interest on a huge amount, at the end you actually owe very little principal as it’s almost paid off.

Now the bank can only charge interest on what you owe them as interest, so when you have paid your monthly interest in full any extra money can be applied to reduce the principal, which means next month they can only charge you less interest because you have a lower amount you owe in total.

Biweekly mortgage would do the same as making one extra payment per year, it’s just a way to make it seem easier to do.

#16

Brief hijack for my curiousity - is this typical in the US? I don’t know anyone in the UK that gets paid every two weeks, almost everyone is monthly. A lot of lower paid jobs are weekly but i’ve never heard every two weeks.

#17

Yeah, it’s pretty common here. The U.S. Military gets paid bi-weeky, as well as federal employees, probably the majority of corporations too. Some get weekly paychecks, but monthly paydays are rare.

#18

Companies are all over the place in terms of payroll schedules in the U.S. but biweekly is pretty common. I do some payroll analysis for mega-corps and they pay weekly, biweekly, semi-monthly, and monthly or some combination of those among their employees.

#19

Unless things have changed, they get paid bi-monthly rather than semi-weekly in the military. Most big corporations, I imagine, pay you bi-monthly rather than semi-weekly too, although that often goes hand in hand with your exemption status. I think my companies hourly employees are paid weekly, but we salaried folks are bi-monthly, meaning that we only get 24 direct-deposits (who really gets paychecks anymore?) per year, rather than 26 if it were a true semi-weekly payment schedule.

I made an extra principal-only payment to my second mortgage last month. That one payment knocked off three months from the end of my loan, because you have to look at it this way: today, I owe (making up round numbers here), $10,000. So from today through the next 15 years, I’m paying compound interest on today’s balance. If I reduce today’s balance to $9,500, then the interest for the next 15 years is based on that amount. Your payments stay the same, so the consequence is your loan is paid off earlier. Another option would be to ask your bank to re-amortize your mortgage so that your payoff date stays the same. This will decrease your payment slightly every time you re-amortize, but that seems like a bad idea and there’s no good reason to do so, even if the bank would cooperate.

Also keep in mind that there’s often no way to tell the bank the purpose of your payments. Look at these two situations: you have a $1000 payment, so you send in $2000. Most banks will automatically credit the extra $1000 as a principal reduction. But… suppose you send in your normal $1000 payment, and then a week later send in what you imagine is a principal reduction check for $1000? In all likeliness, your bank will credit this as your next payment due! It’s not their fault, they don’t know what you intend. This is a bad thing, because it’s just principal+interest(+escrow if applicable) and you see no interest savings down the road. (In my case, it turns out that my bank lets me program principal-only payments electronically, so I did once or twice while figuring out what to do with what would normally have been my car payment.)

#20

I worked at one place that paid monthly and it took some planning to get used to budgeting that way. I’m now getting bi-weekly which I find easier to plan with, especially if I don’t count on the 2 months during the year that I get an extra check. This month happens to be one of them so it feels like getting a bonus.

On the mortgage payments I always pay extra each month to bring the principle down but I wouldn’t want to sign up for a plan like the one described. I have the discipline to consistently put the money towards the payment but still have the flexibility to shave some off if I have unexpected expenses. My budget allocates the higher amount but it’s nice knowing there’s some padding there if I ever really need it.