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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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