Home » Debt, Real Estate

Which Mortgage to Pay Off First

17 August 2012 3 Comments

One of our readers sent in this question:

“I have two mortgages one on my residence and one on my rental property. The interest rate on my rental is 5.25% and on my home the rate is 3.25%. I was paying additional principal monthly on my rental as the rate is higher. However, I have 8 more years on my rental property and a balance of about $40,000. And I have 15 years on my home mortgage of a balance of $83,000. Since the loan is longer on my home mortgage would I save more money/principal by paying on my home mortgage?”

My answer:

To answer the question of which mortgage to pay of first the rental or primary, it would be good to have a little more details such as: Country and state you live in, current tax bracket and your age.  Based on the country and state we can better understand the tax implications of paying down the mortgages. (I’d recommend highly to spend 30 minutes with a good CPA in your city to get the full tax implications based on your location and income bracket.  Even if it cost you $250 for the 30 minutes, it will be worth it.)  Your age is also another factor just because you may have different priorities at 20 something versus 50 something.

However, I’ll do my best in answering the question without that information.

Since we don’t provide legal or tax advice, I’m answering the question strictly based on what I would do in your situation based on my personal experience of owning several rental properties, a second home and a primary residence.  I’ve also consulted with tax professional based on my situation for similar questions.

First, when paying down debt I look at two things the balance and interest rate, in that order.  My goal is to always pay down the lowest balances first, with the intention of using the payment to pay down the next lowest balance.  (That was very important so I’ll repeat it. “With the intention of using the payment to pay down the next lowest balance”)

If the balances are close (within 5%), then I look at interest rates and start paying down the loan with the higher interest rate first.

In your situation, you have one mortgage with $40,000 left and one with $83,000.  It works out pretty well because not only is the lower balance a higher interest rate but it also has 7 years less in payments left.

Here is the amortization schedule for your primary residence.

 

 

 

 

 

 

 

 

 

 

This the mortgage schedule for your rental property.

 

 

 

 

 

 

 

 

 

 

Let’s assume you don’t put any additional payments each year toward paying the $40,000 mortgage down any faster and you have it paid off in 8 years.   Now you’re payment of roughly $511 (Principal and Interest Only), could go to pay down the mortgage on the primary residence.

With an additional $511 each month, you’d have the primary home paid off 3 years and 5 months early, with over $2,605 in interest savings.

Here is what paying $511 additional each month would look like.

 

 

 

 

 

 

 

Now, if you took just $100 per month and used that to pay down the $40,000 mortgage, you’d have that paid off 18 months early.

 

 

 

 

 

 

 

Then start paying down the $83,000 mortgage with an extra $611 per month and you’ll pay off that balance paid off 4 years and 7 months early.

 

 

 

 

 

 

 

In conclusion, I’d pay down the rental property first with any extra cash I have and once it’s paid off, use all of the payment toward paying the next mortgage off early.

Please provide comments below based on your experience of what’s worked for you in situations like this.

Here are some other articles and resources to help in making the decision:

How to pay down your mortgage early

Mortgage Calculators

Mortgage Calculators for Paying Down Early

3 Comments »

  • Jean said:

    Thank you very much for your expertise and time. This is my question and I am 45 years old and live in Hampton, Virginia. I work for the public school system and pay 20% in taxes. I have waivered in whether it is better to pay on rental or my primary residence principal balance. Utilizing mortgage calculators, I save more in interest paying on my primary residence. However, having rental income to pay on home balance would be helpful.

    This anwser made me give this more thought and I am very appreciate. So I looked at the mortgage calculators again and calculated in having the rental income to apply to my home mortgage after rental is paid off. My savings in interest comes very close.

  • SpeedyLoanSearch said:

    These days you have to question whether borrowers actually want to pay off the second mortgage, as many are underwater and may default intentionally. Anyways, imagine if you’ve got an interest-only option on your first mortgage and a second mortgage with a higher mortgage rate. You may want to make interest-only payments on the first mortgage so you can allocate as much as possible to paying down the principal on that costly second mortgage.

  • Helen said:

    I have also have two mortgages to pay . Recently I started to have some financial problems and I had problems paying them each month. My friends suggested to consult some reverse mortgage companies in order to find a solution to my problem. So far they helped me and I am happy I am not in danger of loosing my house.