The number of mortgage programs has exploded in recent years. Many of these, such as option adjustable-rate mortgages, allow borrowers to make very low initial mortgage payments and pay little, if any, principal. At the other end of the spectrum, bi-weekly mortgages, which have been around for decades, are structured to speed up amortization and pay the loan off ahead of schedule.
With a bi-weekly mortgage, one-half of the regular mortgage payment is deducted automatically from a checking account every 14 days, or 26 times a year in all. By making more frequent payments, the borrower makes what amounts to a ’13th mortgage payment,’ and pays off the debt much sooner. For a bi-weekly mortgage, a loan that normally takes 30 years to pay off will take about 22 years to pay off at current interest rates.
The loans come in two forms. With a ‘true’ bi-weekly mortgage, each principal payment is applied directly to the loan balance. The borrower executes legal documents specific to this product, including a bi-weekly note and mortgage rider. If the borrower wishes to change to a monthly payment program, then a refinance is required.
In a second format, the borrower's checking account is debited every two weeks, and funds are place into a separate ‘trust’ account. When the mortgage payment is due, funds are withdrawn from the trust account and regular monthly payments are made. At some point during the year, the trust account accumulates enough funds for the 13th payment, and that's when the principal curtailment occurs. In this case, the borrower signs standard monthly-payment mortgage documents.
According to Geoff Lawes, president of GCL Trading, based in Upper Montclair, N.J., ‘The typical bi-weekly borrower is one who is well organized fiscally and understands the higher cost of borrowing money over a 30-year term versus a shorter term of 10 to 20 years. The bi-weekly borrower recognizes a savings of interest costs by paying off a mortgage in about 20 years compared with 30 years for a traditional payment plan.’
Lawes notes that a bi-weekly mortgage can reduce interest payments by $320,000 for a loan amount of $400,000 versus a conventional 30-year fixed-rate loan. ‘On a typical 30-year fixed-rate loan at current market rates,’ he says, ‘the interest payments total approximately $1,200,000. This compares with approximately $880,000 for a bi-weekly loan of similar terms, or a savings of $320,000 over the life of the loan.’
Convenience is another benefit. Nancy Monson, mortgage product specialist for Harland Financial Solutions, says many consumers are paid every other week and this lines up well for paying their mortgage. ‘Since the payment is deducted directly from a bank account,’ she adds, ‘it makes the process very simple for the customer.’
Bi-weekly mortgages are a good fit for consumers who wish to build equity in their homes more quickly. Scott A. Taylor, manager of the mortgage services division with Lenexa, Kansas-based TruHome Solutions, LLC, says a lot of borrowers would like to pay off their loan early but don't have the discipline to pay the extra principal on a regular basis. ‘This takes the thought process out of it,’ he says.
Brian Hirt, director of product management with Fannie Mae, says that while the bi-weekly mortgage is a niche product, most lenders offer it. He says, ‘For the borrower who wishes to build equity in their home and wants to save a lot of money over time, this is the ideal product.’
Monson says half of Harland Financial's user base that offer bi-weekly mortgages are credit unions. ‘Many credit unions were chartered to serve an employer base,’ she notes, ‘and their members, therefore, are more likely to have a direct deposit arrangement with the credit union. Even as some credit unions have converted to a 'community charter,' the banking arrangements seem to remain in place.’
She says it's been an ‘easy sell’ for credit unions, adding that a lot of their members are asking for a bi-weekly option. She reports, ‘Many of their members are becoming more sophisticated about financial planning and realize that these loans help them build equity more quickly. When stock markets go through turmoil, consumers see a safe haven in their homes, and the bi-weekly product fits that need.’
Loan performance on these products tends to be strong. Taylor says, ‘We have few delinquencies. Occasionally, a borrower will forget to fund the checking account and that generates an 'NSF' notice, but these situations are almost always resolved before the next draft is due. Overall, the servicing is seamless with very little customer interaction.’
Fannie Mae's Hirt agrees that bi-weekly mortgages perform exceptionally well. He says borrowers who pay their loans with a checking account draft tend to leave those payment arrangements in place even through various interest rate cycles. As a result, prepayments are lower because borrowers refinance at a slower pace. In addition, he says, because the borrower is paying down the loan faster, there is a ‘deterrence from bad things happening.’
Conversion from monthly payments
TruHome offers the bi-weekly conversion program as a service to its members, charging a one-time setup fee of $150 and a recurring fee of $1 per transaction. Taylor says, ‘We're not out to make money on this,’ and he adds there are several third party services that charge up to $400 to enroll in the program and recurring charges of $4 to $9 per transaction.
These firms act as an intermediary between the borrower and the mortgage servicer. Because funds are held in a separate trust account until the mortgage payment is due, there are potential pitfalls. Mortgage payments for large numbers of borrowers often are commingled in the trust account. If there are accounting errors or fraud, mortgage payments may not get made.
With a bank or mortgage company administering the program, there is less risk as these firms are heavily regulated and are subject to audits of their servicing platforms. Taylor says funds are held in a noninterest bearing account with TruHome Solutions. The funds are tied to the individual loans for tracking.
‘A benefit of our conversion program is flexibility,’ says Taylor. ‘We allow the borrowers to close their loan using standard Fannie Mae/Freddie Mac fixed-rate monthly-payment documents. Since we're not changing the terms of the loan, the borrower enjoys the benefits of the program without going through a refinance. And if they find the extra payments are a financial burden, it's simple for them to opt out of the program.’
By maintaining the original documents, the lender may easily sell these loans to the secondary market. From the investor's standpoint, says Taylor, they're buying a level-payment fixed-rate loan where the borrower makes one large principal payment per year.
‘We rarely use bi-weekly mortgage documents, due to the added complexity,’ he says.
Lender benefits include float income, setup fees and monthly or annual administration fees. In addition, they build stronger relationships with their best customers. With competition continuing to heat up, this is a key feature.
Hirt finds some lenders hesitant to offer the product, since it's a little more intricate to service. ‘There are two payments to process per month rather than one,’ he says. ‘Also, principal and interest must be allocated in a different way than a monthly-payment loan. The product may not be well-suited for a lender with a simple servicing system or one that doesn't want to get involved with this type of program; it can be a drain on resources.’
According to Lawes, bi-weekly mortgages are generally offered to borrowers with the lender interested in putting the loans in portfolio. He adds, ‘However, as with any loan, on occasion a lender may wish to sell a portion of their portfolio, and most often it is another bank and/or thrift eager to render a bid.’
Price and facility of execution can make Fannie Mae/Freddie Mac a second choice, Lawes continues. Private investors price the loans similar to 15-year loans, recognizing the strong credit quality features and limited collateral exposure. As a result, many transactions occur outside of government-sponsored enterprise channels.
‘The portfolios,’ Lawes reports, ‘usually trade on a servicing-retained basis due to the seller's interest in continuing their relationship with the borrower and the automated deduction structure of the loan which keeps servicing costs at a minimum.’
