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Double-check savings on biweekly mortgages

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in Small Business Tax,Small Business Tax Deduction Strategies

Sooner or later, you’ll run across this concept: Take out a biweekly mortgage to replace your monthly mortgage and save money in the long run.

Strategy: Don’t forget to factor in taxes. Because you can generally deduct the full amount of qualified mortgage interest, your “savings” with a biweekly mortgage aren’t as great as they seem.

This doesn’t mean you should dismiss the idea of a biweekly mortgage. You just need to take a long, hard look at all the numbers.

Here’s the whole story: The standard monthly mortgage plan is cut-and-dried. You make payments on a monthly basis 12 times a year. If you opt for a biweekly mortgage, you’re paying the lender every two weeks for a total of 26 payments a year. In effect, you’re making a 13th monthly mortgage payment each year. As a result, you must come up with the cash sooner than usual, but your mortgage will be paid off faster.     

One of the main attractions of a biweekly mortgage plan is that you pay less mortgage interest over the life of the loan because it’s paid off quicker. That’s where the savings come from.

Example: Let’s say you take out a 30-year mortgage for $100,000 at a 5% rate. With a traditional mortgage, your monthly payment of principal and interest (not counting property taxes, insurance or any other costs) would be $536.82. Over the life of the mortgage, you will be paying $93,257 in mortgage interest. If you use a biweekly mortgage, however, you must pay principal and interest of $268.41 every two weeks. In that case, you would pay off the mortgage in a little over 25 years, instead of 30 years. The total amount of mortgage interest saved using a biweekly plan would be $17,164.

At first glance, it appears that you’re $17,164 ahead of the game … sort of.  Let’s assume you’re in the 25% tax bracket for the length of the mortgage. By reducing your mortgage interest payments, you’re forfeiting an extra $4,291 in tax deductions (25% of $17,164). Thus, your net savings after considering taxes is actually $12,873 ($17,164 – $4,291). The net savings will be even smaller if you’re in a higher tax bracket in some or all of those years.

Putting taxes aside for a moment, a biweekly mortgage plan can place a greater strain on your personal budget and also siphon away money that might be used for other purposes.

Instead, you might use the same principle by prepaying mortgage principal on your own. You can pay as much or as little extra as you want each month—or you can pay nothing extra.

Tip: This latter technique still enables you to reduce the length of the mortgage and save money overall, but on your own terms.

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