Did you ever notice how when you move and submit one of those change-of-address forms, your new mailbox is automatically inundated with tons of ads for unnecessary crap?
Entreaties to sign up for services like the Gravel of the Month Club or the Build Your Own Roof Shingles Club or Plastic Potted Plants R Us, things you’ve clearly never expressed any interest in in your entire life.
It’s just the machine cranking into gear. They know where you live, so it’s an excuse to sell you things. And as we all know, if they are advertising something, you don’t need it.
(This also highlights a good reason why I use a PO Box, although it didn’t totally help me in this situation.)
A different kind of machine cranked into gear with me recently, since I am the proud owner a new mortgage home. Since I’ve just spent hundreds of thousands of dollars (or at least promised to pay as much), I guess companies smelled fresh blood or something.
I got a letter in the mail the other day with the heading in both bold, underline, and what I call “inconsistent caps case”. It read:
Eliminate Years and Save Thousands of Dollars in Interest on your loan
Oh give me a break. Really.
It was, as I had expected, the venerable accelerated payment plan. Which I already knew was a bad move, but hear me out to learn why.
Table of Contents
Making simple things complex
The standard way of paying your mortgage each month is: pay your mortgage each month.
This is pretty simple and straightforward. And as with anything simple and straightforward, it’s easy to concoct a more complex version of affairs designed to confuse people enough into thinking that it’s a better deal.
The way the accelerated mortgage plan is advertised is that you can sign up for the following options:
- Semi-monthly
- Bi-weekly
(Sometimes there’s even a Weekly option, but let’s ignore that one here as it doesn’t change the argumentation.)
Let’s take each option on their own.
Semi-monthly
Semi-monthly means that you make two payments per month, instead of the usual one payment per month.
One theoretical advantage here is that many people get paid twice a month, so the payments can match your schedule. However, if you have sufficient float in your account, this shouldn’t matter. You can just as easily save up and make a single payment. You gain nothing by paying half the amount twice as often.
It’s also not guaranteed that you’d even pay down your balance any faster. It’s known that some of these companies will hold payment until they have a whole month’s worth, so that you don’t even save the minuscule amount of interest by paying a little bit more frequently. It’s all pointless bookkeeping. Avoid this.
Bi-weekly
Bi-weekly means that you pay every two weeks. This means in effect that you will be making 26 payments a year instead of 12 (or 24).
Now, if these plans divided the same total into different pieces, we’d still be in the same place, balance-wise. But as I understand it, the plans set you up to pay a month’s worth of payment with every two payments. So after a year, you’ve paid 13 monthly payments instead of 12.
This does indeed allow you to pay your principal down faster and reduce your total interest, as you have in effect paid 8.3% extra over the course of a year.
But here’s an idea: why not set your regular monthly payments to be 8.3% more? It is effectively the same thing.
(I say “effectively” because it all depends on when the payments are applied. But even if the payments are applied more frequently, we’re still not talking about any significant difference in interest saved.)
Why I hate these schemes
If all these plans offered was a different way to let you pay however it was convenient for you, then I would just let it go.
But if it’s just for my benefit, then why would I be getting such an impassioned call to action? “Act Now! Special Offer Expires Soon!”
Yes, of course you guessed it. Signing up for these plans costs money. Different companies have their own fees, but my research indicates that enrollment fees fall in the $400 range, plus a small transaction fee for every single payment. And all this for what you could do for free without any help.
Avoid these schemes. Pay your bills on time. Pay extra if you want. Just don’t pay a fee to help pay your bills.
But enough about me. What do you think about mortgage accelerator plans? Have you used one?
4 Comments
dunro
I hadn’t even considered the implications of an additional fee. Fortunately, my accelerated payment amount matches what I’d be paying monthly (in total) aside from the extra 2 payments in the year — i.e. no additional fee. Great to think about though!
Mike @ Unlikely Radical
Hi there. That’s great, so it’s net zero cost, and just a different payment plan. That works!
I wonder if we’ll see more of these options as a free service (as differentiation) or if we’ll see more of these options as a pay service (as a supplementary way to extract money from people when rates are low).
Thankfully I’m no longer receiving an offer a day now. Maybe they’ve given up.
Al Ryzy
The point of the bi-weekly or accelerated plans are the interest is calculated monthly by the lender. By staggering the payments within the month, one of the payments is fully applied to the principal whereas a once a month payment is applied to the interest only and not to the principal. Typical mortgages use the monthly payments to pay down the projected interest first, then the principal. This takes up to 13-15 years of a 30 year mortgage. Although the algorithm changes as the interest rates change. The higher the rates, the faster the loan gets paid. Back in the late 80’s when interest rates hovered around 10%, a 30 year mortgage would be paid off in less than 22 years. Additionally, due to the accelerated principal pay down, the homeowner would realize nearly double the equity available on the property.
The original strategy was to shop mortgage lenders for the best 30 year rate then after closing, apply for the plan.
Mike Pumphrey
Thanks for responding. I guess the question is this: If paying 26 times per year against a monthly calculated interest means that the principal gets paid down slightly faster, does that offset the cost that mortgage companies charge you to implement this? I have a suspicion the math doesn’t add up in our favor.
Personally, I think just paying a little extra with each monthly payment is the simpler option. But I think we can all agree that we don’t wish to repeat a time when mortgage rates were 10%!