Which to pay down: 1st or 2nd mortgage?
|  Dear
Dr. Don,
I bought a home in California in February 2006 for $400,000. I financed
with a 10-year interest-only mortgage with a rate of 6 percent and
a 15-year equity loan with a rate of 9¼ percent. I would like to
make extra monthly principal payments on one of the two loans but
don't know which one it would make more sense to pay extra on. Please
advise.
-- Anna Amortization
 Dear
Anna,
First, figure out if either loan has a prepayment penalty associated
with additional principal payments. It's possible that, even for loans with
a prepayment penalty, you can make some additional principal payments and it won't
trigger the penalty. An extra $100 per month, for example, may not trigger
a penalty.
With no penalty to consider, it's a slam-dunk to pay
down the loan with the higher interest rate. Even though the
lower rate loan is interest-only, making additional principal payments
saves you the interest expense on that payment. You'd rather
save 9¼ percent on the additional principal than 6 percent.
The only argument for prepaying the
lower cost first mortgage instead of the equity loan is that a prepayment saves
the interest expense over a 30-year amortization versus the 15-year amortization
of the equity loan. That presumes that you're in both the house and the loan
for more than 15 years. That's not typical. Go with the higher percentages
and pay down the loan with the higher percentage rate.
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