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More for Less?

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Posted On: 10/15/2008

Q: I was told that if one extra payment were made for a 30-year loan, that loan would be paid off in 22 years while two payments would reduce the loan term to 15 years. Is there any truth in this? I currently have a $55,000 loan at 6.5 percent over 30 years. It looks like I'll have to pay back $85,000. If I made one extra payment, how soon would it be paid off, and then if I made two payments extra, how would that benefit me?

A: With a $55,000 fixed rate loan at 6.5 percent interest over 30 years you pay $347.64 per month for principal and interest. If the loan is held to maturity you will pay $70,150 in interest over 30 years in addition to $55,000 principal amount

If you make one extra payment at the start of the loan term you are really borrowing $54,652.36 ($55,000 less $347.64). With the same monthly payment, the loan will be repaid in 353 months instead of 360 months. If you made the equivalent of two extra payments up front, the loan balance would be reduced to $54,304.72 ($55,000 less $347.64 x 2). In this case the loan term would fall to 346 months - meaning the loan's length would be reduced by more than a year.

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As you pay more money up front there is less principal and a smaller monthly interest cost. Since the monthly payment cost is fixed the loan will be paid off quicker with prepayments.

With an adjustable-rate mortgage the result might be different. You could have a lower monthly cost, or if interest rates rose your monthly payment could increase despite prepayments and the loan term would not be reduced.

Q: We bought a property that was zoned residential and later changed to commercial/business by the county zoning board. When we acquired the property, we had no trouble with a residential mortgage. Then we tried to get a new mortgage and could only get a 20-year commercial loan, which is a monthly ARM. We pay a set amount each month that pays extra principal. Although we have not suffered because of interest rates, we have tried numerous times to get a fixed rate. Because the bank appraisers find the commercial zoning, we are turned down. We pay residential taxes and have never had a business on the property. One bank explained that because of the zoning there is always a chance we may start a business. Is there anything that can be done about this or should we just keep what we have.

A: There's good news here. First, you have a 20-year mortgage that you're prepaying. This means your loan will be paid off in less than 20 years, your debt is declining each month and mortgage payments are not a credit issue.

Second, the highest and best use of your property is likely to be commercial and not residential. You may well have a property that has increased significantly in value because of the revised zoning, so ask local brokers about the sale and lease pricing of your property.

As to a new loan, speak with local lenders and ask this question: If you agreed in writing to use the property only as a residence during the loan term could you then get a fixed-rate mortgage? Make sure you're allowed to have a home office, but not allowed to have a sign out front or to lease the property for commercial purposes while the loan is outstanding.

Q: My wife and I purchased a home and paid cash for it. We were both wondering about the capital-gains tax exemption when we sell. We should profit about $100,000. Since we file jointly, would we owe any tax on the profit?

A: The basic rule is this: If you have resided in the property for two of the past five years then up to $250,000 in sale profits are excluded from taxation if single, up to $500,000 if married.

For specifics, please see IRS Publication 523, Selling Your Home.

Q: I want to buy a house and rent out some rooms to offset the rent. Will lenders go for this?

A: There are some programs that will allow the use of rent from boarders - but only if the boarders are related.

The problem for lenders is that they have no way to know if income from boarders will actually come through. That puts them in the position of looking at a loan application from someone who cannot afford the monthly payments. That's uncomfortable for lenders, and not without reason.

Peter G. Miller is the author of The Common-Sense Mortgage and a veteran real estate columnist. Have a question? Please write to peter@ctwfeatures.com.

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