Which to Pay First - First or Second Mortgage?

Perhaps you find yourself with the pleasant problem of trying to decide what to do with an unexpected windfall of cash. Maybe you received a bonus at work, a sweet early retirement package, an inheritance or trust fund, or you hit the lottery. Whatever the source of your newfound funds, it's always a smart strategy to use extra money to pay off debts and free yourself up from lingering monthly payments. If you have mortgages, it may be wise to pay them off, or at least pay down some of the principal.

Analyzing the loan terms

If you have both a first and a second mortgage, it's important to look at the specific terms of the loan and decide which to pay down first. If you have an adjustable-rate mortgage-either a first or second-and you expect that interest rates will rise, consider paying that one off first, and keeping any fixed-rate mortgages. If both of your mortgages are adjustable and you think rates are moving up, consider using your extra funds to pay the closing costs of a mortgage refinancing, and combine the two mortgages into one fixed-rate loan. Another idea, if you can afford it, is to pay one mortgage off completely, and refinance the remaining adjustable rate mortgage to a fixed rate. And if you have more than one fixed rate loan, pay off the loan that has the highest interest rate first.

Some loans are more complicated, such as hybrid loans that combine a fixed rate with an adjustable rate. But almost all loans, no matter how complex or exotic they may be, involve a scheduled transition from attractive lower monthly payments to higher payments-or from low interest rates to higher ones. The higher payments may kick in after an initial period of discounts, but nevertheless, they will come. Like birthdays, they tend to arrive sooner than you'd like. Any loans that have higher future rates should be paid off in full, if at all possible, or at least refinanced into fixed rate loans.

The key to using your money wisely is to pay off any mortgage loans that may go higher in the future, and to refinance any notes that you can convert to lower fixed rates. This will save you cash over the long haul.