6. Jan sold her house on December 31 and took a $10,000 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 receive? b. How much interest was included in the first payment? How much repayment of principal was included? How do these values change for the second payment? c. How much interest must Jan report on Schedule B for the first year? Will her interest income be the same next year? d. If the payments are constant, why does the amount of interest income change over time?

Explanation:

Mortgage value = $10,000

Nominal Interest rate = 10%

Number of mortgage years = 10 years

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

Calculating Semi-annual Payment (PMT) using financial calculator:

Semiannual Interest Rate  = 10%/2

Number of Mortgage periods = 10*2

Present Value of Mortgage Value (PV)  = -10000

Semi-annual Dollar Payment on Mortgage Loan (PMT)  = $802.43

b) Semi-annual Payment = $802.43

Interest paid in 1st year = $10,000 * (10%/2) = $500

Principal paid in 1st year = $802.43 - $500 = $302.43

Total loan balance at the end of 1st year = $10,000 - $302.43 = $9,697.57

c) The interest amount for the second payment is $484.88

The total interest of the year = $984.88

Her income interest will not be the same next year because as years increase, interest decrease.

d) The loan is amortized, meaning that the principal amount is also repaid along with the interest payment. The principal amount decreases period after period. Interest is calculated based on the principal amount, the amount of interest income also changes.

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