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'Profit' and 'Equity'

July 29, 1990

Don Campbell and your reader were both misled by the word profit. Profit is the selling price, less the original price paid, less selling expenses. Accelerated payments are really a form of indirect savings and not increased profits.

By accelerating their payments the young couple are giving up other opportunities for using that money. Let us assume one of these is putting the $100 each month in a savings account earning 5% per year. After five years, they will have $6,800 in this account. This is $943 less than accelerating payments against the mortgage.

A second choice would be to accelerate payments against debt that is costing them 12% year, say a car loan. On the same basis as the mortgage acceleration, after five years, the debt would be reduced by $8,167. This is better by $424 against the mortgage option.

Of the three options, the best opportunity is to accelerate the car loan payments.


Los Angeles

Don Campbell replies:

When in his question my letter writer used the word "profit" when he clearly meant "equity," my first instinct was to change the copy accordingly. The second instinct was to let it stand, but insert a reminder that the two words are not synonymous. The moral here is: Go with your first instincts.

Despite the fact that I subsequently bracketed "profit" in quotes as a reminder to myself that is was the reader's word, not mine, and that this was where the clarification should be inserted, it somehow wasn't done. It didn't blunt the validity of the point being made: That a relatively modest acceleration of principal payments over a five-year period can have a dramatic impact on the amount of cash equity available for the down payment on a replacement home of equal or greater value than the one being sold--and on which there is therefore no tax consequence. But it's true that in my desire to make this point, the distinction between "profit" and "equity" got lost in the shuffle.


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