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Crunching Numbers for a Biweekly Mortgage
You have read or heard the advertisements: Take out a biweekly mortgage to replace your regular monthly mortgage and save money in the long run. It's a sound principle and it works. But don't assume that it's always the best approach.
Reason: You should also factor taxes into the equation. Since you can generally deduct the full amount of qualified mortgage interest, your savings with a biweekly mortgage are not as great as they seem at first. Moreover, you have to make payments sooner than normal, which can hamper your cash flow.
That's not to say you should dismiss the concept of biweekly mortgages either. You just need to take a long, hard look at all the numbers.
Basic premise: The standard monthly mortgage plan is cut-and-dried. You make payments on a monthly basis 12 times a year. If you opt for a biweekly mortgage, you are paying the lender every two weeks for a grand total of 26 payments a year. In effect, you are making a 13th monthly mortgage payment each year. As a result, you must come up with the cash sooner than usual, but your mortgage will be paid off faster.
One of the main attractions of a biweekly mortgage plan is that you pay less mortgage interest because of the amortization of the extra payments. That's where the savings come from.
Hypothetical example: Let's say you take out a 30-year mortgage for $100,000 at a 6% rate. With a traditional mortgage, your monthly payment of principal and interest (i.e., not counting property taxes, insurance or any other costs) would be $599.56. The biweekly payment comes to $299.78. Over the term of the mortgage, you will save $24,136 in interest and pay off the loan over five years early.
However, don't forget that mortgage interest is generally deductible on your personal tax return. For simplicity, we will assume you are in the 28% tax bracket for the length of the mortgage. By reducing your mortgage interest payments, you are forfeiting an extra $6,758 in tax deductions (28% of $24,136), reducing your net savings by that amount. The net savings will be even smaller if you are in a higher tax bracket in some or all of those years.
Note: A portion of your mortgage interest deductions may be slightly reduced if you are in a higher tax bracket. For 2005, the reduction begins for taxpayers with an adjusted gross income above $145,950. However, this tax provision is scheduled to be gradually eliminated, beginning in 2006. It goes completely off the books after 2009.
Putting taxes aside for a moment, a biweekly mortgage plan can place a greater strain on your personal budget. It is also siphoning away funds that might be used for other purposes such as income-generating investments.
Possible alternative: You can adhere to the same principle by prepaying mortgage interest on your own. If you are not held to a strict biweekly regimen, you can pay as much or as little as you want each month-or not at all. This technique enables you to reduce the length of the mortgage and save money overall, but on your own terms.