Mortgage Insurance vs. Piggyback Loans: Which is the Better Bet?

Mortgage insurance will be tax-deductible in 2007, and for some homeowners, the new law means it will be cheaper to get mortgage insurance than to get piggyback mortgages.

Hundreds of thousands of homeowners will save a total of $91 million when they file their tax returns in 2008, according to estimates prepared by the mortgage insurance industry.

The bottom line for consumers, according to Holden Lewis of Bankrate.com: Don’t get a piggyback mortgage without taking a serious look at mortgage insurance, because mortgage insurance is likely to be cheaper in the long run, and it might even cost less in the short run.

Here’s a look at how a piggyback loan and mortgage insurance match up:

According to experts, a homeowner with a $180,000 mortgage would save about $351 in taxes per year because of the mortgage insurance law that was just passed. This assumes the borrower has a good credit score and is in the 25 percent tax bracket.

When you buy a house, a mortgage lender considers you a risk if you make a down payment of less than 20 percent. There are two main ways to make you pay for that risk: mortgage insurance and piggyback loans.

Mortgage insurance is the old-school method. You, the borrower, pay for the policy, but the lender is the beneficiary. If you fall behind on the loan payments and the mortgage company has to foreclose, the mortgage insurance policy reimburses the lender for legal costs and lost income.

The premiums depend on the size of the home loan, the percentage of the down payment, your credit score and the type of mortgage insurance you get.

When you use a piggyback mortgage, you get two home loans: a primary loan for 80 percent of the house’s value and a second mortgage for the rest of the money you need. With a 5 percent down payment, you would get what’s called an 80-15-5 mortgage: an 80 percent loan, a 15 percent piggyback and 5 percent down.

In turn, getting a piggyback loan effectively eliminates the need for mortgage insurance. The piggyback can either take the form of a fixed-rate home equity loan or a variable-rate home equity line of credit. The piggyback has a higher rate than the first mortgage.

The combined payments on a piggyback mortgage are a bit less than the payment on a single loan with monthly mortgage insurance premiums. For years, piggybacks had a big advantage because the mortgage interest on both mortgage loans was tax-deductible; mortgage insurance payments were not.

Now that has changed, with these caveats. The tax deduction applies only to home mortgages that are closed in 2007. If you currently have a home mortgage loan with mortgage insurance in 2006, you won’t be able to deduct the premiums in the 2007 tax year unless you refinance in 2007.

There are income limits. You get the full deduction if your adjusted gross income is $100,000 or less. The amount you can deduct phases out rapidly after that, and no mortgage insurance deduction is available if you make more than $110,000.

This is a one-year deal, and Congress would have to renew the deduction to make it apply for the 2008 tax year and beyond. Of course, if you opt to take the standard deduction instead of itemizing deductions, the new mortgage insurance tax credit makes no difference to you.

When you put those complications aside, the new law makes it easier to compare loan offers. Everything is now on equal footing. Mortgage insurance is tax-deductible and piggyback mortgages are tax-deductible.