I’ve been hammering on the idea of focusing on the big wins instead of worrying about $3 lattes here and there. It’s far better to focus on cutting 25% off the two biggest areas of your spending than to worry about saving 5% on 50 things.
Any time you make a major purchase, there is a huge amount of money to optimize. And buying a house is the best example of this.
Even though buying a house is usually not a good investment, once you have a mortgage, you can optimize the hell out of it.
Instead of paying off your mortgage once per month, set up a system to pay it twice per month. I’m not telling you to double your payments. I’m saying that paying every two weeks WILL mean several years less of payments.
Here’s how it works with Bank of America [Countrywide] and I’ll assuming it works this way with others. BofA has a plan (PayPlan/26) which means instead of making 12 payments a year you are paying 26 payments a year. Note the math. It seems like you should be paying 24 payments a year, but that’s not how the calendar works, so you make extra payments. But, that’s a good thing. It’s like you are making 13 payments a year [the way BofA does it, more on this below*] Let’s take a look.
Scenario 1: Typical Mortgage
APR: 6%, $300K, 12 monthly payments of $1798.65, total interest paid over 30 years, $347,514.57
Scenario 2: Making an extra payment each year
APR: 6%, $300K,? 26 bi-weekly payments of $899.38, total interest paid over 25 years, $276,591
You just saved almost $71,000 in interest payments. Wow, that’s like 18,000 lattes or one every day for the next 50 years.
What’s happens if you have bad credit and have higher interest rates than 6%. Moving to every two weeks helps even more. At a 7% interest rate, you will shorten your loan by 6 years instead of 5 years for the 6% rate. Better yet, you save from paying $98,545 in interest.
Scenario 3: Making extra payments each month
Okay, this doesn’t save you a lot more, but you stop payments 5 months sooner and your interest payout is $273,852 for an extra savings of $2739.
The problem with the scenarios above is unless they are automated, most of us will never do it. That’s why the BofA PayPlan/26 plan is great. It’s automatic.
Here’s what sucks about the plan. One, they charge a $4 fee every month. Okay that’s $2600 over the course of the loan. But, the bigger issue is this. They don’t apply your mid month payment right way, rather, they hold your money like a bank and then make a payment with your two payments at the end of the month. Thus, the plan really is a 13 payment plan. This is pretty downright snaky in my book and I think [hope] the regulators jump on this. According the scenarios above I should be saving another $2739, but I’m not.
I’ve seen many posts that complain about the fact that the banks charge for this service in many different ways. I agree with these complaints, but I want to point out that I disagree with the advice most posters give. They say, get a bunch of envelopes and be disciplined about this. I just don’t think “discipline” is realistic for most busy people. (Note from Ramit: See Personal finance is not about more willpower.) Sure, I’m bummed about paying $2600 for something I should be able to remember to do, but that $2600 is saving me $71,000. So, it’s a tradeoff I willingly accept.
But all this said, the upside totally outweighs the downside. It’s an automatic way to save you more money than you could save almost anywhere else and you’ll be paid off 5 years earlier.
Andy Jolls is an ex-FICO executive and Chief Educator at VideoCreditScore.com. Check out these videos:
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- How to translate your credit score into an interest rate.
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