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so I have two mortgages on two separate rental properties.

A. 100k remaining, 1 year left on term, 1.85% variable, 428 monthly.
B. 300k remaining, 4 year left on term, 2.54% fixed, 313. weekly.

I have 100k to pay down, which do I do and why?

eliminating A will allow me to have an extra inflow of 428 each month.

but Ill be paying more in interest over the course of the term of paying for B, so wouldnt it make sense to knock off some there? however I will have that extra 428 expense to deal with from not paying off A

I am in Canada.

Edit: It seems like the Bank of Canada plans several rate hikes this year, which will increase the variable rate.

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3 Answers 3

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Mathematically you should pay the one with the higher interest rate, since you'll pay less interest over the remaining life of the loan.

Practically I see at least three very good reasons why paying the lower-rate loan off completely may be the best move:

  • It frees up that monthly payment to pay down other debts, or start/accelerate investing for retirement.
  • You're only paying 0.69% extra (~2k per year) on the second loan if you pay the first one off instead.
  • There's a very good chance that the interest rate of the first loan will increase over the next year, or when you refinance.

Not to mention the psychological benefit of having a loan off of your mind and an extra $428/month of flexibility in your budget.

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  • 1
    thanks stanley, couple of questions. 1) Could you expand on first bullet? Do You mean the savings of the 428 can be used to pay off the loan B? 3) Are you saying when I have to renew Loan A in a year - the rate will be higher - and could be similar rate to Loan B?
    – Jonnyboi
    Commented Feb 7, 2022 at 15:20
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    Yes and yes, but I didn't catch that these are Canadian mortgages and typically have prepayment penalties, which would come into play in either case. Please check with your lender on what the prepayment penalties would be - it may not be worth the interest savings.
    – D Stanley
    Commented Feb 7, 2022 at 15:24
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    Let's say interest rates will go up a percent a year from now. a) you pay off the variable. In a year you have 300K debt at 2.54% b) You pay off some of the fixed. In a year you have to refinance the variable, probably at 2.85%. Now you have 200K at 2.54 and 100K at 2.85, which is worse than scenario a.
    – DJClayworth
    Commented Feb 7, 2022 at 16:19
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    @Jonnyboi Not much - you'd pay about $300 per year more in interest (100,000 * (2.85% - 2.54%))
    – D Stanley
    Commented Feb 7, 2022 at 23:04
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    There may be another practical reason: if you remortgage A, is there a fee associated with that new mortgage? How does that fee compare to the costs (associated with mortgage B) of paying A off? (In the UK, it's not unusual for mortgage fees to be £1000 or £2000 or more.)
    – Steve Melnikoff
    Commented Feb 8, 2022 at 9:41
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Left out of the other two answers is the issue of the security interest.

If you make large principal payments on the larger mortgage, but fail to pay it off, and then end up in a situation where you default on the loan, the mortgage holder will still seize the property. Those additional principal payments will then simply be lost, as the mortgage holder will have 100% of the equity in the property and you will have 0%.

In some jurisdictions if the mortgage holder sells the property for more than the outstanding debt when they seized it, they are supposed to return the overage to the foreclosed party. In practice, when the property is auctioned the mortgage holder is usually the only bidder, and they bid low enough that there is no overage left over, regardless of what the mortgage balance may have been when they foreclosed.

If there is any chance whatsoever of any future adverse event making it remotely possible for you to enter foreclosure on either property, the low-risk course of action is to completely pay off the smaller loan as soon as you can.

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Beyond the question as framed, does the $100k have to be directed toward paying down these debts?

Do you have other potential investments that could yield more than the mortgage interest? Do you have secure income (i.e., rent payments) that will let you continue to pay these mortgages?

Even if the answer to the latter two questions is 'no', you should consider the optionality value of $100k in the bank vs the potential $428/month cash flow. For example, if some major repair expense came up, financing it would probably be at a much higher rate than 2.54%.

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