The hidden catch of biweekly mortgage payments

Posted: November 21, 2010

The economic downturn has certainly freed up space in my mailbox. I'm not getting as many credit-card and refinancing offers as I did before the fourth quarter of 2008.

My mortgage servicer, hoping to milk another pint from homeowners who aren't in default, makes monthly contributions to my family's recycling efforts with offers for accident and dismemberment insurance, and life insurance, and low-interest credit-card balance transfers.

My policy is to check the payment data and shred the rest.

An offer that hasn't eased, however, is the one about switching to biweekly mortgage payments.

I've written about this before, but e-mails from Bernadette Fox of Downingtown and a few anonymous folks were enough to make me address the issue again.

I won't single out lenders, because they all do it, but the culprit in Fox's case is one of the top five on the reader-complaint list and the Mortgage News monthly rankings.

Fox switched to a biweekly payment plan to shorten the time to her mortgage payoff - she was told that the loan would be paid off a year sooner. What she didn't realize, she said, was that the payoff time is shortened only because "I am making an extra month's payment over the course of a year."

That became apparent when she received her quarterly statement. It seemed the second payment each month was "unapplied" until the end of the month.

In other words, there was no reduction in interest because the lender had half the monthly payment, including the escrow, two weeks earlier than necessary.

The lender's explanation: "The computer system is not set up to apply the payment earlier."

So Fox switched back to regular monthly payments, because, she said, "I am able to accomplish the same thing by just making an extra principal payment each year."

It requires discipline to make an extra payment, but not much, based on my own experience and that of other readers who tried biweekly plans and switched back.

Fox asked me whether what her lender was doing was illegal, a sort of bait and switch. My research uncovered no foul play, unless the lender said in writing that paying twice a month would mean a reduction in the compound interest.

I doubt it did so, although the movie title that best describes the financial system today is Dumb and Dumber, with even fewer laughs.

You see, it is likely that the servicer is still paying the loan monthly, so a biweekly payment means lending it money interest-free for two weeks a month. Paying the servicer twice a month simply increases the number of payments each year to 13 from 12. That's how an extra payment reduces principal.

I'm sure that this biweekly privilege wasn't free. I've seen enrollment charges as high as $300.

So, in at least two respects, Fox's servicer was hardly being altruistic in offering her biweekly payments.

I don't know about your mortgage balance and interest rate, but a year-earlier payoff seems to be a relatively small reward and not worth the trouble or expense.

What would be is a payoff four or so years earlier. As Bankrate.com columnist Holden Lewis advises, "The higher the interest rate, the more you shorten the repayment period."

The extra amount I pay on my principal each month varies with expenses. Sometimes, you get an unexpected whopping electric bill in a hot summer month and adjust plans to reach that total 13th payment by year's end.

That's another caveat to biweekly payment plans. If you do enroll in one, Lewis advises, see if it allows enough flexibility to let you switch back to a monthly payment temporarily, when midmonth bills rise without warning.


Inquirer real estate writer Alan J. Heavens is the author of "Remodeling on the Money" (Kaplan Publishing). His home improvement column appears Fridays in Home & Design. "On the House" appears Sundays in The Inquirer. Contact Alan J. Heavens at 215-854-2472 or aheavens@phillynews.com.

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