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It happens every month: The credit card bill is due. You dutifully send your minimum payment on the due date — but watch the balance grow ever larger.
But what if you could pay half that amount every two weeks instead of one payment every month?
More payments, you say? Thanks, I’ll pass.
But what if the new payment schedule could save you hundreds of dollars?
Biweekly payments are a simple way to reduce your balance and the amount you pay in interest. Here’s what you need to know.
How Do Biweekly Payments Work?
You may have already heard of — or received offers for — biweekly payment plans for debts like your mortgage. Here’s how one works:
Let’s say your monthly payment for a debt is $500. If you pay that amount each month, you’ll make 12 payments each year for a total of $6,000.
If you make biweekly payments, you pay $250 every two weeks. But because there are 52 weeks in a calendar year (thanks to that wacky Gregorian), you’ll make 26 half payments or 13 full payments each year, for a total of $6,500.
That reduces your principal by $500 in one year and thus reduces the amount of interest you’ll pay on the remaining balance. Depending on how much you owe and how your debt is structured, you could shave months or years off of a payment plan.
An amortization schedule is a table listing regular payments for the life of a loan. Each amount includes a little more toward principal and a little less toward interest as your balance goes down.
You can check out your loan’s amortization schedule and online biweekly payment calculators to see just how much you’ll save by paying off principal early.
How to Decide if a Biweekly Payment Plan Is Worth It
There are three questions to ask about your debt before switching to a biweekly payment plan, according to Brian Walsh, Certified Financial Planner and manager of financial planning at SoFi, a personal finance company:
1. What is the interest rate on the debt?
Before you start planning out a new payment schedule, you should first know if it’s worth your effort. That starts with knowing how much interest you’re being charged on a debt.
“We consider good debt as anything with an interest rate below 7% and bad debt, anything with an interest rate above 7%,” Walsh said.
Rather than paying off “good debt” early, you can often put your money to better use by investing in IRAs, 401(k)s and other accounts that offer a higher interest rate than the one you’re paying.
So if you have a mortgage charging 5% interest and an IRA earning 8%, you’ll make more money in the long term by continuing with your current monthly debt payment plan and putting that extra money toward your IRA. But if you have an auto loan charging 9% interest, you should consider a biweekly payment plan to pay down that debt faster.
2. Are there any prepayment penalties associated with the debt?
Before starting a biweekly payment plan, review loan contracts to be sure it doesn’t include a prepayment penalty. If it does, you’ll be charged extra for paying off a loan or a large portion in a single payment, which could offset any benefits you reap in interest savings.
3. Can you apply the extra payments toward principal?
This question typically requires you to simply tell your lender — via phone, email or letter — that you want extra payments applied toward your principal amount, not the interest. That allows you to pay down the debt faster and avoid paying extra in interest.
When it comes to meeting all three criteria, there’s typically one debt that’s a clear winner, according to Walsh.
“Whenever we come across credit cards, to me, that’s a no brainer,” Walsh said. “People should be setting up biweekly and more frequent payments when it comes to a credit card.”
Why You Should Set Up Biweekly Credit Card Payments
If there’s ever a chance you’ll carry over a balance from month to month on your credit card, biweekly payments can save you hundreds in interest, according to Walsh.A grace period is the time between when a statement closes and the due date. The 2009 Credit Card Act requires that if a credit card company offers a grace period, it must last at least 21 days.
The problem with credit card debt is that unless you pay off the full balance every month, you lose the grace period credit cards typically offer and start accruing interest on a daily basis.
By making biweekly payments, you’ll not only knock out more of the balance, you’ll avoid accruing additional interest in those 14 days between payments.
Why Biweekly Mortgage Payments May Not Be Worth It
So credit card biweekly payments may sound all well and good, but what about knocking out most people’s biggest debt, the mortgage?
Not so fast, say the experts.
Using a biweekly payment plan to pay down your mortgage typically isn’t the best financial decision, according to Jason B. Ball, a certified financial planner with Ball Comprehensive Planning in West Linn, Oregon.
To illustrate this, Ball offered a scenario using the example of a house purchased for $300,000 with a down payment of $50,000 and an interest rate of 4.2%:
|Traditional Monthly Payment||Biweekly Payment|
|Total Interest Paid||$182,510.84||$153,169.81|
|Pay-off Date||30 years||25 years, 8 months|
Here’s how much you can expect to save by making a biweekly payment as opposed to a traditional monthly payment:
- Interest: $29,341.03
- Time: 4 years, 4 months
“In our example, it looks to save about four years,” he wrote in an email. “It is also interesting to note that most people do not live in their home that long. The typical buyer could be expected to stay in a single-family home roughly 12 years before moving out.”
Yes, you’d save on interest (although not as much if you move out before you finish paying off the mortgage), but Ball notes that at 4.2%, you could put your extra payments to better use by investing that money in higher yielding investments like a low-cost diversified portfolio inside a 401(k), Roth IRA or traditional IRA.
And although it might make you feel better about not having a mortgage hanging over your head (and there are other benefits to paying off your mortgage early), there’s a good chance a paid-off house won’t help you out that much financially even if you do decide to stay there when you retire.
“If you put all your money into your mortgage, you may be house rich at retirement, but you need to look at how you will turn that asset into a monthly paycheck at retirement,” Ball wrote. “Typically, pre-paying the mortgage yields a lower probability of retirement success than other options.”
Should You DIY Biweekly Payments?
So you’ve weighed the pros and cons, and you’re ready to put yourself on a biweekly payment plan. Now what?
Even if your lender offers biweekly payments, setting up a formal plan may not be the wisest option, according to Walsh. In addition to possible fees, a new contract locks you into a payment schedule that you can’t back out of if your financial situation changes.
While some borrowers may appreciate the discipline, it’s typically an unnecessary step — not that you’ll necessarily even have that option.
“Unfortunately, every lender doesn’t support this to make it really easy where you click the ‘easy button’ and then it automatically just comes out biweekly,” Walsh said.
And what about those offers you see online and in your mailbox — the ones that offer to take care of a biweekly payment plan for you?
“People tend to want to offload this to another third party service that says, ‘Hey, we can do this all for a certain fee or a certain percent,’” Walsh said. “Those fees can end up being pretty high and may outweigh the benefits of those extra payments.”
When setting up automatic payments in your account, remember that every month doesn’t have the same amount of dates. So don’t schedule one on the 30th, or you’ll miss a payment in February.
Your best option for paying down debt on your terms and without the fees? Hint: Look in the mirror.
“What we see a lot of times is this has to be a DIY approach,” Walsh said. “But the good news is it’s not that hard to implement.”
If you’re paid by your employer on a biweekly basis, good news: It’s easy enough to schedule payments to coincide with your paycheck. If you don’t get a paycheck every other week, you can still set up your bank account to make biweekly payments for a debt:
- Determine your monthly payment.
- Divide that amount by 2.
- Schedule automatic payments from your checking account for every two weeks.
- Check in with your account on months with 31 days (January, March, May, July, August, October and December — thanks again to that zany Gregorian) to ensure your payments are still reaching your lender by the due date.
“It’s not a really time-consuming process, it’s just remembering to do it [and] setting it up,” Walsh said. “Most lenders don’t make it super easy.”
Paying biweekly isn’t a quick-fix solution for all your debt. (If you’re looking to pay off massive amounts of debt quickly, check out how Jen Smith and her husband paid off $78,000 in debt in two years using the starve and stack method.)
But if you’re looking for a less extreme way to save a few hundred dollars (or thousands, depending on the debt), the biweekly payment method could ease you into cutting down your debt.
This story was originally published at The Penny Hoarder.