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Biweekly mortgage? Calculate tax cost first

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in Small Business Tax,Small Business Tax Deduction Strategies

You've read the advertisements: Save money in the long run by replacing your regular monthly mortgage with a mortgage paid biweekly (every two weeks). It's a sound principle, and it can save you money. But don't assume it's always a slam-dunk.

Advice: Factor in taxes when you crunch the numbers. Since you can usually deduct the full-qualified mortgage interest, your biweekly mortgage savings aren't as great as they first appear. Plus, you'll have to make payments more frequently, which could hamper your cash flow.

Benefit: Pay mortgage off sooner

The standard monthly mortgage plan is simple: You pay on a monthly basis. If you opt for a biweekly mortgage, you pay the lender every two weeks for a total of 26 payments a year.

As a result, you must come up with more cash than usual, but you'll pay off your mortgage sooner.

The main attraction of a biweekly mortgage is that you pay less total mortgage interest because of the extra payment amortization. That's where the savings come from.

Example: Switching to biweekly

Let's say you take out a 30-year $100,000 mortgage at 5 percent. With a traditional mortgage, your monthly principal and interest (i.e., not counting property taxes, insurance or any other costs) payment would be $536.82. Over the mortgage term , you'd pay $93,257 in interest.

If you used a biweekly mortgage, you'd pay $268.41 principal and interest every two weeks. In that case, you would pay off the mortgage in a little over 25 years, instead of 30 years. The total mortgage interest using a biweekly plan would be $76,093.

At first glance, it appears that you'll save $17,164 by switching to a biweekly mortgage ($93,257 monthly plan minus 76,093 biweekly plan). True...sort of.

Don't forget that you can typically deduct mortgage interest on your personal tax return. For simplicity, we will assume you're in the 25 percent 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 percent of $17,164).

So your net savings, after calculating the missed tax breaks, is actually $12,873 ($17,164 minus $4,291). The net savings will be even smaller if you're in a higher tax bracket in some or all those years.

Remember: If you're in a high tax bracket, tax rules could slightly reduce your mortgage interest deductions. For 2004, the reduction begins for taxpayers with an adjusted gross income (AGI) above $142,700. (Note: This limitation is scheduled for a gradual elimination, beginning in 2006. It goes completely off the books after 2009.)

Consider self-imposed plan

Putting taxes aside for a moment, a bi-weekly mortgage plan can place a greater strain on your personal budget. It may also siphon away funds that could be used for other purposes, such as income-generating investments.

One option: Instead of signing up for a biweekly mortgage plan, you can follow the same principle by prepaying mortgage interest on your own. If you're not held to a strict biweekly regimen, you can pay as much or as little extra as you want each month. That technique allows you to reduce the length of the mortgage and save money overall, but on your own terms.

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