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PAYING DOWN FIRST OR SECOND MORTGAGE FIRST?
Do you have two mortgages? Are you earning extra
money and would like to start contributing towards
paying one of them down but are not sure which one? This
is a common dilemma faced by many homeowners. Featured
below is a letter we recently received related to this
topic, as well as our response.
Dear Star Loan Services,
I recently purchased a home in San Francisco in March
2006 for $500,000. My mortgage consists of a 10-year
interest-only loan with a rate of 6.5 percent and a
15-year equity loan with a rate of 9.5 percent. I would
like to begin making extra monthly principal payments on
one of the two loans but I am not clear as to which one
it would make more sense to contribute more towards. I
appreciate any help you can offer.
Regards,
Confused in California
Dear Confused in California,
The first thing you need to do is determine if either
one of your loans has prepayment penalty fees associated
with the principal payments. It is possible that even if
the loan does have a prepayment penalty that you can
still contribute extra payments towards the principal
without triggering the penalty. For example, an extra
$200 per month likely won't trigger a penalty.
If there are no penalties to be concerned about with
either loan, then the obvious thing you should do is pay
down the loan with the greater interest rate. So, paying
more of the interest only loan is the wiser decision.
You may be saying to yourself, 'but its interest only'.
Think about it...you will save more money on future
interest expenses by paying down the principal of a 9.5
percent loan as opposed to the 6.5 percent mortgage.
There is one counter argument to prepaying the mortgage
with the lower cost first in stead of the home equity
loan. The prepayment is going to save you more in
interest expenses over a 30-year amortization versus the
15-year amortization of the equity loan. This is
assuming that you are going to be residing in the home
for longer than 15 years and that you do not pay the
loan off early. However, this scenario is not typical.
Go with the greater percentages and pay down the loan
with the higher percentage rate.
Regards,
Star Loan Services
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