Why borrowers should pay off higher-rate mortgage first

Piggyback situation complicated by primary adjustable loan

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Q: My wife and I recently purchased a new home and avoided mortgage insurance by taking a piggyback: Our first mortgage is a five-year interest-only adjustable-rate mortgage (ARM) for $296,000 at 5.375 percent for 30 years. Our second mortgage is a 15-year fixed-rate mortgage (FRM) for $55,000 at 7.01 percent. Our cash flow allows us to pay more than the interest on the ARM and the full payment on the FRM. Should we apply the excess to the ARM or to the FRM? A: The general rule is to pay down the higher-rate debt first, which is the second mortgage. If both mortgages were FRMs, this would be a no-brainer; you would allocate all surplus cash to the second until it was paid off. The same is true when the first mortgage is a five-year ARM and you confidently expect to be out of the house within five years. On many piggybacks, the first mortgage is fixed and the second is adjustable with a higher rate. In this case also you would channel excess cash flows toward the second. But if the fi...