My wife and I started shopping around different financial options when buying our first home. When doing so, I learned that there is always someone trying to sell you on something you don't need. This time it was the rule of the 1/12th.
In case you did not already know, if you add 1/12th to your mortgage payment over the course of a year you will have made one full extra payment. Over the course of a 150,000 mortgage you will have shaved off 7 years and saved about $51,000 in interest.
To help you understand I will break down two different ways you can make mortgage payments. But first let me tell you what the mortgage brokers pitch was.
The Pitch
He told us that there is a great offer right now, instead of making payments once a month we could set up a payment plan to make 1/2 payments every other week. That would cut our mortgage down to 23 years rather than 30 years and save us a little over $51,000 in interest. This payment plan would only cost us $500 to set up. Sounds like a great deal! Pay $500 to save over $51,000 can't beat that deal..........I told him that we most likely would set that up but I would let him know. We went through the loan process to get the home purchase going and we left.
The first thing I told my wife when getting in the car was that I do not really understand why we would have to pay to make payments. This was our first home purchase, it was all too new to us and I did not really know what to think. The whole idea of paying a fee to pay our mortgage just did not add up. I went home to put some numbers down on paper and after a few simple math problems I realized I had a question for him.
I went back to his office the next day and said to him that by making 1/2 payments every other week, over the course of one year I will have made one full extra payment. He agreed and said that is correct. My next question to him was why don't I just add 1/12th more to each monthly payment, (one more full payment divided up 12 months) that would equal out to be the same as paying 1/2 payments bi-weekly. This would also give me the same results when it came to the amount of interest saved and the number of years it would cut off my loan. He was now getting a little hesitant when he said that is correct because the broker knew where I was going with this. This then lead me to my final question, what is the benefit by giving him $500.00? His response wasn't very good, he said that people don't have the self control to do it themselves. I was respectful by saying that you should include that in your sales pitch so you don't come off as being a con. I then left being very thankful that I put some thought into that before acting on it. I really did think that it was a good deal at first.
In case you are little confused on this I did my best to break down two different ways to pay your monthly payment:
You can pay your minimum balance every month or you can make payments every other week. If you do not want to pay every other week but still have the same result you just add 1/12th of your monthly payment to your monthly payment.
The number of FULL payments in a year if you pay each month = 12
The number of FULL payments in a year if you pay half of your monthly payment every other week or add 1/12th to your monthly payment = 13
Example:
Say your monthly mortgage is $1,000
If you pay monthly = $12,000/year The math: (1000 * 12 = 12,000)
If you pay 1/2 every other week = $13,000/year The math (500 * 26 = 13,000) or
(1000 * 1/12th = 83.33 then 1000 + 83.33 = 1083.33 then 1083.33 * 12 = 13,000)
Basically it boils down to making one extra full payment a year if you pay 1/2 of your mortgage every other week or by adding 1/12th to your total monthly payment.
The 500 dollars he wanted was for nothing...and it made me open my eyes just a little bit more for when people want my money for something.
If you are in the process or are going to be in the process of buying a home, do not be sold on the 1/12th. Just know that if someone is trying to sell you on paying every other week and wants to charge you for it, now you know to say "No thanks I can manage it myself." To shorten your number of years and decrease your total interest paid just add another 1/12th or even 2/12th to your loan payment. Don't be a sucker.
Comment with questions if you want.
Happy Savings!
Dustin
