Borrower nearly halfway through term learns shocker

Ilyce R. Glink
Inman News

Q: I read your column regularly and it is very helpful and informative.

My question is in regards to paying extra on the principal of ones mortgage. I realize that prepaying on the loan, whether it is just a little or the equivalent of one additional payment per year, is a good thing. Also, thanks to your column, I am aware that I can reduce a 30-year loan to 21 years by making that extra payment each year.

I took out a 10-year loan in August 2003. The loan will be paid off in July 2013. I made an additional payment last year with the idea of shortening my loan. Can you tell me how much this will shorten my loan and whether this is even worth doing on such a short loan? Making our monthly payment is not a problem.

A: Because you are paying off your loan in 10 years instead of 30, you’ve already cut the amount of interest you’ll pay over the life of the loan. And because you’re already more than four years into your loan, prepaying at this point will offer you little benefit. It will shorten the term of your loan a tad, however.

If you were starting to pay off a 10-year mortgage today, one extra payment per year would slash only a year off of your loan. Two extra payments would slash your 10-year loan to about 8.5 years.

How much will you save overall? Assuming you took out a $100,000 loan at 5 percent, you’d pay about $28,000 in interest over the 10 years of the loan term. If you make two extra payments per year, you’ll pay just over $22,000 in interest, a savings of $6,000.

The reason you don’t save any more than that is that the big savings comes when you’re able to cut more years off of the loan. For example, if you have a 30-year loan at 6.5 percent, and you make an extra payment each year, you’ll pay off your loan in 25 years, and save $28,000 in interest. If you double your payments, you’ll pay off the loan in nine years, and save nearly $97,000 in interest.

But at only 10 years, you’re not borrowing that much money for very long. So, prepaying doesn’t give you the same savings as on a longer loan term.

To play around with the numbers, go to the tools section at Eloan.com. Look for mortgage calculators and click on the amortization calculator.

Q: My husband inherited his fathers house with the stipulation that the father’s current wife would have a life estate. When she decided to move from the area, we settled with her to sign over the deed for $25,000.

When we sold the property, the accountant used the numbers listed for the property value when my father-in-law passed away instead of the value of when my stepmother-in-law signed over the deed.

Is this correct? My feeling is that we did not become the actual owner of the property until the deed was changed and therefore should be charged capital gains only on the value as of that date. Thank you for your time.

A: While it seems as though you didn’t own the property because you didn’t have complete control over it until you paid off your stepmother-in-law, your husband was in fact the owner of the property once your father-in-law died.

Here’s how life estates work: The property passes to the “remainderman” (your husband) once the owner dies. That’s when ownership is considered to transfer. The person who benefits from the “life estate” (your stepmother-in-law) typically pays the taxes, insurance and mortgage on the property. Once she dies (or signs away her rights to the life estate), the remainderman has complete control over the property.

While she has some control over the property during her lifetime, your stepmother-in-law would not be able to sell the property or transfer ownership because your husband was the true owner — and that ownership interest had some value at the time your father-in-law passed.

While he owned it already, the $25,000 he paid your stepmother-in-law bought your husband the right to currently use the home. The accountant would have taken into account the value of the home at the time your husband inherited the home and may have included the $25,000 as an amount paid to obtain full rights to the home.

Please talk to your accountant again for more details.

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Copyright 2008 Ilyce R. Glink

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