Two Time Loser
In the last year, just about every homeowner in America with a long-term mortgage has received a solicitation offering to collect the mortgage payments in twenty-six bi-weekly installments instead of twelve monthly ones.
The pitch: the conversion to bi-weekly will help you to pay off your loan several years earlier than scheduled, save tens of thousands of dollars in interest, and the new payment program will cost only a small set-up fee and service charge.
It’s a great country, isn’t it?
There are two separate issues in these solicitations. Do these bi-weekly sysytems perform as the slicitations say, at reasonable cost? And second, is faster payoff a good idea, or just a feel-good idea?
As to the first issue, the math is correct. Twenty-six one-half payments are the same as thirteen whole ones, which means that any switch to bi-weekly payments will result in an extra annual principal payment equal to a regular monthly payment. If you send in that amount of extra principal each year — whether bi-weekly, semi-annually, annually, thrice monthly, or in 52 increments on Tuesdays — you will shorten a 30-year loan by seven years or so (the exact number of years varies with how soon after closing you begin to make the extra payments).
The fee structure?
North American Mortgage Company, a large servicer of mortgages (remember: the people to whom you send your payment do not own your loan, nor are they a “lender”; they are all contract servicers, mere conduits for your payments) charges a one-time fee of $379 for its “Bi-Saver”, and another $1.00 per payment. Washington Mutual Bank (actually a Savings & Loan which has fallen in with bad company) wants $320 to start its “Equity Accelerator” and $2.50 per payment. Chase, Norwest, Bank of America… all the big loan servicers are selling the same basic deal.
The reasonableness of the fee versus the service?
P.T. Barnum would be pleased. A new fool may not be born every minute, but they are not in short supply. And, it’s nice to know that so many have found work — though personally embarrassing, as so many seem to have gravitated to the banking business.
For the fee you get the extra payments yanked electronically from your bank, and nothing else. The servicers don’t even bother to credit your account at mid-month, so you are still paying interest for an extra two weeks on each extra payment. The servicer no longer has to open envelopes containing your messy, hard-to-read, expensive-to-process, and possibly rubber checks.
I don’t know why servicers think enough people will sign up for these deals to recoup the postage for the mailings. Two possible motivations come to mind. First: one marketing theory holds that consumers think free services have no value; therefore charge a few hundred bucks and people will think the bi-weekly service is worth something.
A second marketing theory: when selling a scam, always try to get your hands around the victim’s emotional throat, or appeal to greed, or both. In this case, feed the desire to own a home free and clear, painlessly.
“Ladies and Gentlemen, hurry along, right over here… this way to the Egress!”
The fees in these bi-weekly deals are bad enough, but the deep scam — where consumers lose the really big money
— is in the prepayment of principal. Any form of prepayment: fifteen year loan, Christmas bonus shipped in lump sum, two, three, four extra monthly payments — all are bad deals.
Space doesn’t allow for the mathematics of the argument (though you can find the whole story at www.boulderwest.com, “Essentials” numbers 3 & 4). However, the basic idea: almost any form of savings wisely invested will earn more than the mortgage interest saved by prepayment. Don’t send in spare cash to the lender, invest it. Start with the tax-advantaged stuff (IRA, 401K, 403B, PERA, TIAA, Keogh…), then hello, Vanguard!
Free and clear ownership may make sense when you buy the last house, all on one level, when the kids are gone, and your income and tax bracket are way down. But in the meantime, cash paid to “build equity”, doesn’t change your net worth — your wealth — by ten cents. It just turns a flexible, investable financial asset into rigid, can’t-get-it-when-you-need-it home equity; and turns the house into an under-leveraged and under-performing real estate investment.
There are only two kinds of mortgage borrowers who should commit to programmatic prepayment. Those who are too nervous about investment to buy anything riskier (and higher yielding) than a CD or T-bill, and those who would blow the extra cash instead of saving it.
But, even for these groups, why pay somebody to help you send in more money?