Mortgage Prepayment When You Have Two Mortgages

July 6, 2004 "Please settle a dispute. On one property I have an old 6.6% mortgage with small balance and only 5 years to go, and on another property I have a relatively recent 30-year mortgage at 6.25 %. Most of the payment on the first mortgage is principal while most of the payment on the second is interest. I say that any excess funds we apply should go to the 6.25% mortgage because so little of the payment is being applied to principal, but my wife thinks we should apply excess funds to the higher-rate mortgage." Score one for your wife. You should allocate excess funds to the higher rate loan. The composition of the scheduled payment changes over time, as you note. Early in the life of a mortgage, most of the payment goes to interest, but as the balance falls over time, an increasing share goes to principal. For example, your old loan with a $20,000 balance at 6.6% and 7 years to run has a payment of $ 298, of which $188 goes to principal and $110 to interest. Your new loan of $50,000 at 6.25% with 29 years to run has a payment of $312, of which $52 goes to principal and $260 to interest. However, if you add to your scheduled payment, 100% of the increment goes to principal in both cases. If you add $100, the principal payments on the two loans would rise to $288 and to $152, respectively. You would earn 6.6% on this $100 if you applied it to the first loan, and 6.25% if you applied it to the second. In short, how your scheduled payment is being divided as between principal and interest should have no bearing on how you allocate excess funds. Copyright Jack Guttentag 2004

Jack Guttentag is Professor of Finance Emeritus at the Wharton School of the University of Pennsylvania. Visit the Mortgage Professor's web site for more answers to commonly asked questions.

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