Here at CGN, we like to distinguish between productive debt and consumer debt. Productive debt is a tool to help you invest in an asset, such as a mortgage or student loans (usually, but that’s a conversation for a different day). Consumer debt is unsecured debt or debt on a depreciating asset, such as credit cards, lines of credit, and vehicle loans – still tools, but much more dangerous and avoidable if you establish a savings plan.
Just because mortgages and student loans are productive debt doesn’t mean you don’t still have to evaluate your options and make good decisions, however. For example, it’s still a better idea to be able to make a 20% down-payment in order to avoid private mortgage insurance and establish some equity instead of financing over 95% of the cost through a VA loan in an unstable market and ending up upside down for a number of years.
One smart option I’d like to highlight is setting up your mortgage on a bi-weekly payment plan. Just like paying a little bit extra per month, this option can literally take years off of the length of your mortgage.
Those who receive a paycheck bi-weekly already know that this means there are two months out of the year where you get a third ‘bonus’ paycheck. In much the same way, setting your mortgage payment up bi-weekly allows you to make a ‘bonus’ payment towards your mortgage every year.
Here’s how it works:
Your finance company will calculate your monthly payment the same as usual, as if you were paying monthly. Then, they split the monthly payment in half to figure what your bi-weekly payment will be. NOTE that bi-weekly is different that twice a month. Then, two months out of the year, you’ll end up making three mortgage payments instead of two.
These two extra payments add up to a full month’s payment and – get this – it’s 100% applied to the principal (instead of your regular payments, which will be almost all interest and no principal the first several years).
Employing this strategy will help you pay off a 30-year mortgage almost exactly 4 years earlier (or a 15 year mortgage 18 months earlier). That would save you around $20,000 in interest on a $200,000, 30-year mortgage.
***A word of caution: Employing this strategy correctly requires you to set up the mortgage as bi-weekly payments right from the beginning. Paying bi-weekly is different that making two half payments a month, and finance companies (depending on the company) may just put any extra money towards the next interest and principal payment, so be sure to ask questions.