Which mortgage should I pay extra to each month?
October 22, 2012 10:18 AM   Subscribe

I am not wonderful at math. I am trying to figure out which mortgage I should pay an extra principal payment to each month. Will you help me?

The details are as follows:

1. Primary residence has a mortgage of ~355000 at 3.875% for 30 years (new refi).

2. Rental property has a mortgage of ~135000 at 3.875% for 15 years (new refi).

I am hoping to pay an additional $1000/mo toward one of these. What logic would you use to figure out which mortgage to put this toward? Which payment will save me more?

I have looked at bankrate mortgage calculators but I get confused when I think about the 15 vs 30 year loan. Also, once the rental mortgage is paid off (either early or at year 15), I would be able to put that monthly rent received toward extra monthly payments on my principal residence, in addition to the $1000/mo.

Thanks for your insight!
posted by rabidsegue to Work & Money (11 answers total)
What you have isn't really any different from a single mortgage of 490,000. The maths alone says it doesn't matter which you pay more towards.

I have two different mortgages (for the same property) at different rates. I overpay where I can on the one with the larger interest rate.
posted by pipeski at 10:28 AM on October 22, 2012 [1 favorite]

Mortgage interest is frontloaded on a loan. If you look at your statements every month, on a new refi, some piddling amount is going towards principal. The larger, longer loan will cost you far more in interest over its lifetime. Paying it down will save you the most money.
posted by Michele in California at 10:28 AM on October 22, 2012 [2 favorites]

Numbers-wise, it's not going to matter one way or the other because the interest rates are the same -- you're "retiring" $1000 of debt that you'd otherwise have to pay 3.875% on.

As such, it's a question of what you want to accomplish. In general, you will have more flexibility in the future if you pay the 15-year mortgage first, since you can always choose to pay less on the 30-year note (down to the standard payment) if you have something else you'd rather spend the money on. Paying down the 30-year mortgage would be a good choice if you want to force your own hand, though, or if you'd like to be mortgage-free after roughly 15 years.

Side note: assuming your interest on both mortgages is tax-deductible and depending on your risk tolerance, I would encourage you to consider other investment options for the $1000/month. Money at those rates is very cheap.
posted by backupjesus at 10:30 AM on October 22, 2012

When are you planning to sell either of them?

As I understand it, once you're thinking of retiring, you have more options if you have more equity in your personal residence, especially wrt to reverse mortgages. If you're nowhere near retirement, that probably doesn't matter.

Also, what are your plans for the rental? Are you planning to live off the income forever, and die still owning the property? Or are you planning to sell it in some particular time frame, or once it's appreciated X%? Do you expect the property to appreciate much at all?
posted by small_ruminant at 10:50 AM on October 22, 2012

Best answer: Do you want more total dollars saved over time? Then you want to pay off the 30-year note. $1000 extra/month, if you started repayment on the 30-year note today, is $136K in savings, knocking a 30-year repayment schedule down to a little over 15 years.

If you want to maximize future spending freedom, you'd apply it to the 15 year note. Again assuming you started repayment today, $1000 extra every month will save you about $25K in interest payments, and knock your 15-year repayment schedule down to a little under seven years, after which you would be free to pay down the bigger loan or have an extra ~$1900 a month in extra spending money.

posted by Mayor West at 10:57 AM on October 22, 2012 [4 favorites]

Mortgage interest is frontloaded on a loan.

Frontloading interest is a predatory lending practice that is not practiced by reputable lenders. It used to be a common practice, but is not any longer.

Any amortized debt will show more interest being paid early on in payments than later. The fact that so much of the initial payments on a house mortgage is interest is a function of the length of the mortgage, not the nature of the debt. In any given month, you are only paying interest on the amount you still owe; as that amount decreases, the amount of interest decreases, and the amount of principal paid off increases.

"Frontloading" interest involves setting up the repayment schedule such that 100% of payments go to interest, and principal only begins to get paid off after all the interest has been paid. This has the result that once the interest has been paid off, the lendee has no advantage to paying the loan off early. If the lendee won the lottery the day the last interest payment was made and paid loan off immediately, they'd still have paid all the interest of the full-term loan. This differs from a balloon note in that the lendee paying a balloon note is never paying FUTURE interest.
posted by endless_forms at 11:09 AM on October 22, 2012 [2 favorites]

You're currently set to pay ($600,692.60) total on the 30-year loan, and ($178,639.09)
total on the 15-year loan. (may be fudgey by a few dollars.)

If you pay off an additional $1000/month on the 30-year loan, you end up paying roughly ($546,113.53) on that loan in about 17 years.

If you pay off an additional $1000/month on the 15-year loan, you end up paying ($164,917.37) on that loan in about 7 years.

You save more money on the 30-year loan.

I did this in Excel, though my numbers are consistent with those above.

The big question is what ELSE you might want to do with that money. At such low interest rates, it might be wiser to invest the money.
posted by endless_forms at 11:16 AM on October 22, 2012

The first few answers were correct: The interest rates are the same, so in terms of your net worth, it doesn't matter which one you dedicate the extra money to. Yes, as several people pointed out, if you made the extra payments on the longer loan, you'd "save" more money, but that's just saying that over the lifetime, you'd make more extra payments on a longer loan.

But endless_forms point out that dedicating it to the 15 year would allow you to pay it off in 7 years. After that, you'd have more flexibility: You could choose to continue to make the same total payment (adding both the $1000 and the mandatory payment on the 15-year that you would no longer be making), allowing you to pay off the 30-year even more quickly. But you could also choose to make the mandatory 30-year payment, or something in-between (which is basically what I now see that backupjesus said).
posted by Mr.Know-it-some at 12:13 PM on October 22, 2012

Frontloading interest is a predatory lending practice that is not practiced by reputable lenders. It used to be a common practice, but is not any longer.

"Frontloading" is not a predatory lending practice. That is simply mathematical operation of loan amortization.

Taking the $135k mortgage for example, the monthly payment is going to be $990. Of the first payment, $436 will be interest, but on the last payment, only $3 will be interest. The reason is simple. At the beginning on the loan, there is more principal and therefore more subject to interest. Don't believe me? Use any spreadsheet software's loan amortization template and see how predatory it is. The weird "frontloading" practice that you seem to describe sounds an interest-only loan.

To the question at hand, it doesn't matter which loan is paid down first because, as others have commented, both loans have the same interest rate. I would be tempted to pay off the house, if I knew I was going to stay in it long-term. That way, both loans would be paid off in 15 years. (the house would be paid off in just over 14 years)
posted by Tanizaki at 12:15 PM on October 22, 2012

Best answer: There are also tax benefits to consider. Paying off the rental mortgage faster will raise the taxable income from your properties.

While it is similar to the personal mortgage interest deduction, the first dollar of interest gets a tax benefit in your business. For your personal mortgage, the first 10k of deductions basically don't count due to the standard deduction.
posted by politikitty at 12:55 PM on October 22, 2012

It might be logical to wait until after the election. I think the Romney/Ryan ticket plans to abolish the tax deduction of home mortgage interest if they are elected. If this happens, your situation will be changed substantially.
posted by Cranberry at 3:16 PM on October 22, 2012

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