Sunday, March 1, 2009

Mortgages - The myth of acceleration

This is the first in something of an intermittent series I'm going to do on mortgages. Despite often being a persons single biggest monthly expense, all too often people really do not understand how they work. And since I also get all geeked up doing this sort of stuff... behold.

I sometimes hear people talking about how much faster and cheaper they're paying off their mortgage by going to accelerated weekly or bi-weekly payments... this isn't really true. What they're really doing is just increasing how much they pay in a month.

They basically work by taking what a person typically pays in a month, lets say $2000 (to use a nice round number), and if one wants to pay bi-weekly, they'd just start paying $1000 every two weeks ($2000/2) or $500 every week ($2000/4).

Then, instead of paying $24,000 a year ($2000 x 12), they are paying $26,000 ($1000 x 26 or $500 x 52). So yes, it would be paid off sooner, and they would save a little on interest.... but the same thing can be accomplished just by upping one's payments to $2167 per month though, which is effectively what they'd be paying anyway.

You're not really gaining anything by changing the number of payments. To take a look at just how little one saves on interest, lets use $200,000 over 25 years, at 6% example. That could be paid off for $1288.60 per month, or $297.12 per week.

Over the course of one year a person would save a grand total of.... $12.79.

Slightly over a dollar a month. Which, if you're on a automatic withdrawal, by all means, go weekly, it'll earn you a free lunch once a year.

But if you're doing the old school method of mailing in or dropping off a cheque at the bank, it's really not worth your time.... between postage, time and/or gas you will probably end up going out of pocket.

Another thing to consider is your monthly budgeting. If you're not carrying a decent balance and depending on your work pay schedule on the months you have to make an extra payment could obviously lead to some headaches.

So, in conclusion, there is little to be gained by going to weekly or bi-weekly payments that can't be accomplished by merely increasing your monthly payment... which, if you can afford it, is a good idea regardless of your circumstances.