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'Profit' and 'Equity'

July 29, 1990

Regarding Don Campbell's answer in Mortgage Q&A "Extra Loan Payments Bring More Profit" (July 15), there is a difference between equity and profit .

If you buy your house for $75,000, pay $25,000 cash down and borrow $50,000 at 10% for 30 years secured by a mortgage or deed of trust, and I buy a similar house for $75,000 and pay all cash, you have $25,000 "equity and I have $75,000 equity."

Assume that we both sell at the same time for the same price, i.e. $100,000 and we ignore seller's customary closing costs, your profit is $25,000 and my profit is $25,000, notwithstanding the fact that you will receive only $50,000 cash (your equity of $25,000 plus your profit of $25,000), and I will receive $100,000 cash (my equity of $75,000 plus my profit of $25,000).

If you accelerate the payments on your loan, and reduce the balance owing faster than required, it will not result in an increase in the profit realized but it will increase your equity, and thereby increase the amount of cash you receive upon a sale of the property.

Accelerating the payments will reduce the interest payable to thelender and will increase the cash proceeds to the seller, but it will have no effect on the profits.

DANIEL M. HERSCHER

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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