Question

Jan sold her house on December 31 and took a $5,000 mortgage as part of the payment. The 10-year mortgage has a 10% nominal interest rate, but it calls for semiannual payments beginning next June 30. Next year Jan must report on Schedule B of her IRS Form 1040 the amount of interest that was included in the two payments she received during the year.

a. What is the dollar amount of each payment Jan receives?

b. How much interest was included in the first payment? How much repayment of principal was included?

c. How do these values change for the second payment? (choose one of the following)

1. The portion of the payment that is applied to interest declines, while the portion of the payment that is applied to principal increases.
2. The portion of the payment that is applied to interest increases, while the portion of the payment that is applied to principal decreases.
3. The portion of the payment that is applied to interest and the portion of the payment that is applied to principal remains the same throughout the life of the loan.
4. The portion of the payment that is applied to interest declines, while the portion of the payment that is applied to principal also declines.
5. The portion of the payment that is applied to interest increases, while the portion of the payment that is applied to principal also increases.

d. How much interest must Jan report on Schedule B for the first year?

e. Will her interest income be the same next year? (choose one of the following)

1. Her interest income will increase in each successive year.
2. Her interest income will remain the same in each successive year
3. She will not receive interest income, only return of capital.
4. Her interest income will decline in each successive year.
5. She will receive interest only when the mortgage is paid off in 10 years.

f. If the payments are constant, why does the amount of interest income change over time? (choose one of the following)

1. As the loan is amortized (paid off), the beginning balance, hence the interest charge, increases and the repayment of principal increases.
2. As the loan is amortized (paid off), the beginning balance, hence the interest charge, declines and the repayment of principal increases.
3. As the loan is amortized (paid off), the beginning balance, hence the interest charge, declines and the repayment of principal declines.
4. As the loan is amortized (paid off), the beginning balance, hence the interest charge, increases and the repayment of principal declines.
5. As the loan is amortized (paid off), the beginning balance declines, but the interest charge and the repayment of principal remain the same.

Answer 1

1 a) Interest rate (Semi - Annual) Mortgage amount (PV) No. of semi-annual periods (Nper) 5.00% < = 10%/2 $5,000.00 < 5000 20 <- =10*2 Monthly Loan Payment $401.21 <-- =PMT(C1,C3,-C2,0) 7 b) Interest in First payment Repayment of Principal in first payment $250.00 <-- =C2*C1 $151.21 <-- =C5-C7 Option I - The portion of the payment that is applied to interest declines, while the portion of the payment that is applied to principal increases Principal remaining after first payment Interest in second payment $4,848.79 <- =C2-C8 $242.44 <-- =C12*C1 $492.44 <-- =C13+C7 Total interest to be reported in Schedule B Option IV - Her interest income will decline in each successive year Option II - As the loan is amortized (paid off), the beginning balance, hence the interest charge, declines and the repayment of principal increases 18 d) 19