NEW YORK ( TheStreet) -- It's a good news/bad news situation. The bad news is you've been struggling with payments after taking out a second mortgage some time back. The good news is that you're prospering and ready to make extra payments to trim your debt.
So which loan should you focus on? The original mortgage or the second one?
The answer is simple: The top priority should be reducing the loan with the highest interest rate. Unfortunately, many homeowners get this wrong because of common misconceptions about how mortgages work, says Jack M. Guttentag, emeritus finance professor at The Wharton School.
Many borrowers believe incorrectly that they should pay down the older loan first, because more of each payment goes to principal rather than interest, Guttentag says on his website, TheMortgageProfessor.The most common type of mortgage is the 15- or 30-year "fully amortizing mortgage," or FAM. The interest rate and monthly payment are fixed for the life of the loan. But each payment is divided, with a portion going to interest charges and a portion to the loan balance or principal. In the early years of the loan, most of the payment is interest, with very little to principal. In later years it's the other way around.