Which is more benneficial, 1)to set up a bi-monthly mortgage payment or 2) to make one extra payment each year, and why.

In the end you will accomplish the same result with either. The workings behind a bi-weekly are as follows:

You make a half mortgage payment every 2 weeks, not twice a month. Doing it every 2 weeks allows for 26 half payments a year (13 whole payments). That extra payment per year is what amortizes the loan ahead of schedule. Some people will say that making the bi-weekly allows you to pay slightly less interest, as you are pre-paying throughout the year, as opposed to paying 1 single payment at the end of the year. By the same logic, if you make your 1 extra payment in the beginning of the year instead of the end, you would come out further ahead than paying bi-weekly as all of your additional prepayment would have been made very early in the year.

The moral of the story is that, 1 extra payment per year is going to amortize the loan faster. Paying that additional payment once a year, or a little extra each month, or on a true bi-weekly is less important than actually making sure you make the prepayment. There's no secret in the sauce, it's the extra paying that makes the difference.

AC

LoanAce is correct, it depends on when you make the extra payment, if beginning of the year, then that will save you the most, if at the end, then the Bi-weekly is better.  Both of them are better than nothing, so whatever the client is comfortable with would be the "best" imo

Your best bet would be to send two checks every month.  On the extra payment check be sure to write "apply to principal balance owing". 

I would have to disagree with my colleagues on this one.  A bi-weekly mortgage is clearly better than making one extra payment per year.  The wow factor of the bi-weekly is that it is applied against the loan every two weeks.  The fastest paying loan would be one where you could make a payment each day.  A daily pay loan pays down faster than a weekly, which pays down quicker than a bi-weekly which pays down quicker than a monthly.

I invite any of you to run TIL's under these scenarios to see which pays the least amount of interest.  I have run many calcs on this and have run the numbers through an amoritization schedule.  Making one extra principal payment per year does not pay the loan off faster than a bi-weekly no matter when you apply that extra payment.  Loans with one extra payment per year payoff in about 26 years on a 30 year amoritization schedule.  That same bi-weekly loan pays off in 23.5 saving thousands in interest.

Dean Gorenflo:

I would have to disagree with my colleagues on this one.  A bi-weekly mortgage is clearly better than making one extra payment per year.  The wow factor of the bi-weekly is that it is applied against the loan every two weeks.  The fastest paying loan would be one where you could make a payment each day.  A daily pay loan pays down faster than a weekly, which pays down quicker than a bi-weekly which pays down quicker than a monthly.

While true in theory, in reality it depends when the company actually applies that extra amount in the bi-weekly payment...some lenders and their vendors for the bi-weekly payment plans will actually hold the extra amount in an account and wait 6 months or a year before applying that extra amount to the loan balance...

My experience with bi-weekly mortgages is that the rate is slightly higher than with standard fixed rate mortgages.  Also, the payments are auto-deducted which can remove flexibility you may have in your finances.  Paying extra each month is probably the easiest path to take.

Whatever you do, do not pay some 'service' for the privilege of paying bi-weekly.  They remit once a month and twice a year the extra half payment gets sent along as a principal reduction.

This is why I mentioned the WOW factor of a bi-weekly being applied every two weeks.  If the payment is not applied every two weeks, then the benefits diminish.  Your mention of this is an excellent point though for anyone considering a bi-weekly "conversion".

If your loan was not closed as a bi-weekly loan, you cannot convert it to one.  Conversion would be a hybrid bi-weekly that does not offer the benfit of having the money applied every two weeks.  The money in a conversion would be applied once a month achieving an extra monthly payment per year.  This is NOT a bi-weekly mortgage.  A bi-weekly mortgage must be originated and closed as such.

Loan Ace nailed it. 100% accurate.

All moot.

mortgage acceleration is twice as fast as either...

Ah, but mortgage acceration requires a modicum of fiscal discipline, which many households lack.

In the end, the most beneficial method of payment is the one that the borrowers actually STICK to. A lot of my working class folks (W2ers that count on a refund every february) make that extra payment when the taxes come in (more or less at the beginning of the year) - money they never really counted and spent.

Those that have trouble parting with large sums of money do the every 2 weeks thing, because it "feels" the same as the regular monthly payment. You can often determine whom is of this mindset by whether they think there are two months a year when they receive an "extra" paycheck - as sure sign of paycheck to paycheck monthly mental budgeting.

The best way for an average person to pay off their mortgage early is to make that system of early payment meet them in the middle in terms of they way their view their finances. . . . the true "wow" factor . . .; meaning it didn't feel "hard" to do it. Nothing against the average borrower - some love the calculations, I'm one of them, and I was even before I got into this biz, so I love the acceleration concept - but some do not like to think about it, and the "easiest" method of smart debt service is the best (most motivating) method.

You can actually set up a mortgage acceleration plan so it maintians the same amount of little discipline as a bi weekly payment. As Matt stated, nothing is faster than mortgage acceleration. I used to work with an accountant from the 'big 3' using Mortgage Acceleration and his unique selling proposition was "How to pay off all your debt, including your mortgage in only 7 to 10 years. Without credit card counseling, bankruptcy or making extra payments using the same amount of money you already have."

He taught me everything I know about Mortgage Acceleration. He took his business to the next level once he figured out how to make the process automated for his clients so they didn't have to be super disciplined.

Kelcey:

Ah, but mortgage acceration requires a modicum of fiscal discipline, which many households lack.

In the end, the most beneficial method of payment is the one that the borrowers actually STICK to. A lot of my working class folks (W2ers that count on a refund every february) make that extra payment when the taxes come in (more or less at the beginning of the year) - money they never really counted and spent.

Those that have trouble parting with large sums of money do the every 2 weeks thing, because it "feels" the same as the regular monthly payment. You can often determine whom is of this mindset by whether they think there are two months a year when they receive an "extra" paycheck - as sure sign of paycheck to paycheck monthly mental budgeting.

The best way for an average person to pay off their mortgage early is to make that system of early payment meet them in the middle in terms of they way their view their finances. . . . the true "wow" factor . . .; meaning it didn't feel "hard" to do it. Nothing against the average borrower - some love the calculations, I'm one of them, and I was even before I got into this biz, so I love the acceleration concept - but some do not like to think about it, and the "easiest" method of smart debt service is the best (most motivating) method.

I totally agree with you.  That's a piece of education that should always be done up-front, and dispassionately to boot.  Whenever possible, I have clients set up an auto-draft from their income directly to the HELOC.  Then they're obligated to work the program (provided they don't overspend on HELOC, which is rare).

No disagreement on MA, but this was not the original question.  Based on the original question, a bi-weekly is clearly more beneficial

Maybe a more important question to ask is why pay the mortgage off? 

Why not build up an investment account, that is liquid, generating a rate of return and is safe vs paying down a mortgage. 

Because what happens when GM shuts their doors and you now can't find a job and have a mortgage payment every month unemployment only lasts so long, or you get hurt at work and cannot work and didn't have long term disability insurance?

I don't buy the argument that it is a tax deduction either because so what if you have to claim an additional $10K in a year in income you only need to pay maybe 25% of that in tax, whereas to get the tax deduction of $10K you have to send $10K to the bank.