Buying a house almost always means applying for a mortgage. A mortgage is just a fancy term for a loan specifically used to purchase a house, and that house is used to guarantee the loan will be repaid.
In another article, I discussed the different types of mortgages, so I will not rehash that issue here. Almost every mortgage is set up to be paid monthly. The most common mortgages are 15-, 20-, and 30-year terms. This means you pay the same amount every month for that many years to take full and complete ownership of your home.
The Hidden Price
For those of us that want to own a home, there are few options other than a mortgage (not too many cops have $200,000 in cash they can use to pay for a house). In return for this joy of home ownership, first we need to realize that we are paying a small fortune for this privilege.
Since 30-year loans are the most common, we will use that as a baseline. A $200,000 mortgage at 5% interest costs $1074 a month. For someone, or a family, taking home $4000 a month, that is a reasonable amount. A 30-year loan involves 360 monthly payments, each of which slowly whittles away at the initial $200,000 loan amount. Quick math will show you that 360 payments will cost you a total of over $386,500. Since the loan amount is only $200,000, this means you are paying interest costs of over $186,500. That is the hidden price.
Lowering the mortgage amount lowers the monthly payment and total cost, obviously. A $150,000 mortgage costs $805 a month with total interest payments of roughly $140,000. Raising the interest rate causes significantly higher costs. That $150,000 mortgage at 6% costs almost $900 a month with total interest of about $174,000. That's nearly the same interest payments as the $200,000 loan at 5%!
Lowering the Hidden Cost
As I mentioned, almost every mortgage is set up for monthly payments. Why? I don't know. If could be for ease of calculation as much as for ease of payment. Some of us are old enough to remember getting coupon books where a check was mailed with each coupon monthly. Maybe people did not want to hassle with mailing more than one payment a month. Nowadays, a mortgage can be directly debited from your bank account and an email sent confirming payment.
In the coupon days, people often dreamed of making an extra payment on the mortgage every year. Of course, since it wasn't automatic, and Christmas gifts are purchased at the end of the year, few people actually scrounged up the extra money and sent it in, but the idea lives on. Now with electronic payments, it is easy to arrange.
The trick is to pay the mortgage bi-weekly rather than monthly. For many of us, that is not a challenge, as most Americans are actually paid bi-weekly. That means you have 26 pay periods in a year, and if you pay your mortgage bi-weekly, you get 13 monthly payments in a year. The cool part is the bank takes that 13th payment and applies it solely to the debt owed, reducing future interest payments.
The Math
So what is the effect of this 13th payment? On a $200,000 mortgage at 5%, your total interest payment drops to just over $152,000. That means you save around $34,000 in interest over the 30 years. But it gets better! The 30 years is actually reduced to 25 years and two months. You own your house sooner and pay less for it!
On the $150,000 mortgage at 5%, you save almost $26,000 and pay off your house in just over 25 years. With a 6% interest rate, the savings jump to over $37,000 and the payoff is even faster: 24 years and six months.
I ran all these variations on mortgagecalculator.com, where you can run your own numbers to match your exact situation. If you like the idea of owning your house faster and paying less for it, talk to your mortgage company. My mortgage is with Wells Fargo, and they offer the service free. I spent about five minutes on the phone, gave them my bank information, and they set up the bi-weekly payments automatically at no charge. Some companies charge a small fee to change the payments. Years ago, I had a mortgage company that charged $3.50 a month for the bi-weekly payments; but that was before electronic payments and internet banking were widespread.
Sure, no one likes to be burdened with extra payments. Nevertheless, if you are budgeting with bi-weekly paychecks, it is almost natural to have bi-weekly house payments. And when natural saves you tens of thousands of dollars, can you really pass it up?
Be safe.
