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We’re going to be buying a house within the next year or so. As we consider taking on this additional (and large) amount of debt I’ve been doing research into how to pay it down faster. There are a lot of disputes on the wisdom of this. Many argue that mortgage debt is good debt, that money is better invested elsewhere, that we should take advantage of the tax deduction that comes with mortgage interest

However, I’ve decided that we want to pay our house off early anyway. My ultimate goal is to be totally debt free, so that everything I love is truly mine and so that I never have to face worries about where my next mortgage payment is coming form (like so many people do today!). So, I’ve been looking at different ways in which we can eliminate this debt quickly, and I have found a few different methods or theories.

Obviously, the most obvious way to own your house faster is to take a shorter-term mortgage. Instead of 30 years, which seems to be the standard, we considered taking a 15 year mortgage. However, the difference in payments, even with the lower interest rate, would put most of the houses that we really are interested in out of our price range. We are planning on buying a $500,000 house and putting $100,000 down so we’ll be looking at a $400,000 mortgage. The monthly payments on a 30 year mortgage (figuring 5.75%) would be 2,334.29 a month, a large portion of which is interest and thus tax deductible. However, on a 15 year mortgage, figuring 5.25% interest the payments jump to 3,215.51, and the tax deduction is less because we are paying more of the principle. This is outside of our comfortable range. We could buy a smaller house, but then it ultimately would not meet our needs as our family grows, and we’d have to move (which can be costly if you factor in commission and closing costs, not to mention the time and mental cost).

So, we don’t want to reduce the size of our house, and we don’t want to stretch our budget to take a 15 year mortgage instead of a 30 year mortgage. This left us with a few other options to consider.

We also are mulling over the possibility of taking a flexible mortgage. These types of mortgages are common Europe, especially in the UK. The principle is that you can pay more on your mortgage when you have the money, but you aren’t obligated to do so. In the UK, it is pretty simple to take out one of these mortgages. You take your mortgage with a bank and then have a linked savings account with that bank. The money in your savings account “offsets” your mortgage loan (i.e. if you borrow $400,000 and have $100,000 in the bank, the bank calculates interest as if you borrowed only $300,000). The bank normally sets a credit limit (a limit on the amount you can have in the linked savings account) and you can deposit and withdraw from the account up to the bounds of that limit. Of course, you get paid no interest in the money that is in the savings account, and if you never keep any money in the account then you don’t get any benefits from this.

In the U.S., the IRS doesn’t allow a traditional offset mortgage, but there are 2 banks (CMG Financial Services and Macquarie Mortgages USA) which offer a form of an offset mortgage. The premise is that the borrower takes an adjustable rate mortgage and deposits their paycheck into the mortgage account. These deposits act to reduce the mortgage balance, so that you are lowering your interest rate, but you can withdraw money from this account so you can still access your paycheck. If you are a disciplined saver and spend less than your paycheck, this can save you a lot of money over the term of the mortgage, because the “extra” money out of each paycheck reduces your interest until you spend the money. However, again if you spend all of your paycheck this doesn’t benefit you at all, and if you spend more than your paycheck this can actually really hurt you because this additional spending becomes a part of your mortgage loan.

So, after some consideration, we don’t think that the “offset” mortgage option is for us. It’s not that we don’t think we can save part of our paycheck. The problem for us is that too few banks offer these types of mortgage. Plus, we really aren’t comfortable taking out any mortgage that even resembles an “adjustable rate” mortgage, what with the current state of the housing & mortgage crisis.

So, if we take out a traditional mortgage, how can we pay it down early? There are two different methods that are commonly used in financial circles.

The first is to make bi-weekly payments instead of monthly payments. Using this method, you end up making one extra mortgage payment each year, and you can end up paying off your 30 year mortgage 6-8 years early. However, some banks charge for this service and this also generally doesn’t reduce your compound interest typically because most loan servicing institutions pay monthly even if you send the payments every two weeks.

Ideally, you can achieve the same affect of bi-weekly payments yourself without formally enrolling in a program with your bank. There are a few different ways to do this. You can pay an additional 1/12 of your mortgage each month. You can make 1 extra payment the month when you get your annual bonus (if you are lucky enough to get one!). You can take 1/2 your mortgage payment form each bi-weekly paycheck and put it in a special savings account and write your mortgage check from that account, sending an extra payment twice a year. When you make this extra payment, be sure to specify that you want the money to go towards your principle. Or you can simply call your bank and ask if you can personally send in a check bi-weekly instead of monthly (although some banks won’t allow this, especially those which have a designated & expensive program in place).

Finally, the final option we considered was using the Givens Plan outlined in this article at Get Rich Slowly. Under the Givens plan, when you make each monthly payment, you also pay the “Principle”. For example, if your monthly mortgage payment is $2000 and $1500 is interest, $250 is fees and $250 is principle (this is just an example) then you include an additional $250 in your payment, specifying that this money goes towards the principle. The Article I linked to explains this very well so I won’t rephrase it year, but suffice to say, to me it just makes simple sense.

So, those are all the different options at our disposable. I think at this point we are leaning toward the Givens Plan because that will give us time to grow into the extra payments (as our paychecks grow) and it is also something that we can do ourselves without a lot of time or cost or fees, and something we can stop doing or skip a month on as needed.

So, theres a quick roundup of some different ways to pay down your mortgage faster. I’ll keep you updated as we do further research and get closer to purchasing our house.