On January 1 of year 1, Arthur and Aretha Franklin purchased a home for $1.5 million by paying $200,000 down and borrowing the remaining $1.3 million with a 7 percent loan secured by the home. a. What is the amount of the interest expense the Franklins may deduct in year 1?
b. Assume that in year 2, the Franklins pay off the entire loan but at the beginning of year 3, they borrow $300,000 secured by the home at a 7 percent rate. They make interest-only payments on the loan during the year. What amount of
interest expense may the Franklins deduct in year 3 on this loan (the Franklins do not use the loan proceeds to improve the home)?

c. Assume the same facts as in (b), except that the Franklins borrow $80,000 secured by their home. What amount of interest expense may the Franklins deduct in year 3 on this loan (the Franklins do not use the loan proceeds to improve the home)?

a. What is the amount of the interest expense the Franklins may deduct in year 1?

this will depend on the total interest paid during the year, since we are not told how long their mortgage is, we cannot know exactly how much interest expense they will pay. Generally mortgages require monthly payments, so I prepared a simulated amortization schedule for the first year assuming that the mortgage lasts 30 years and a monthly payment of $8,648.93.

year  beg.     scheduled  principalinterestending

        balance      payment                                      balance

11300000    8649         106675831298934

21298934    8649         107275771297863

31297863    8649        107875711296785

41296785    8649         108475651295700

51295700    8649         1091         75581294609

61294609    8649         109775521293512

71293512    8649         1103         75451292409

81292409    8649         1110         75391291299

91291299    8649         1116      75331290183

101290183    8649         1123  75261289060

111289060    8649         1129  75201287931

121287931    8649         1136  75131286795

total interest                                     $90,582

b. Assume that in year 2, the Franklins pay off the entire loan but at the beginning of year 3, they borrow $300,000 secured by the home at a 7 percent rate. They make interest-only payments on the loan during the year. What amount of  interest expense may the Franklins deduct in year 3 on this loan (the Franklins do not use the loan proceeds to improve the home)?

c. Assume the same facts as in (b), except that the Franklins borrow $80,000 secured by their home. What amount of interest expense may the Franklins deduct in year 3 on this loan (the Franklins do not use the loan proceeds to improve the home)?

Explanation:

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