New Tax Bill Includes Mortgage Insurance Credit

Legislation that Congress passed over the weekend contains a provision that would result in tax savings for many first-time home buyers next year.

The provision nestled in the federal “Tax Relief and Health Care Act of 2006″ would allow home buyers to deduct the cost of mortgage insurance premiums they pay in connection with a mortgage obtained in 2007.

It was one of scores of tax breaks appended to a tax bill approved by a wide margin by the House on Friday and the Senate Saturday morning just before Congress wrapped up the lame-duck session. The bill would cost $38 billion over five years, the San Jose Mercury-News reports.

The bill, which is expected to be signed into law soon, extends a raft of popular tax breaks that had expired, including a $4,000 deduction for higher education tuition, a $250 write-off for teachers who buy classroom supplies, incentives to buy energy efficient cars and home improvements, and more.

The mortgage insurance tax break would mark a big change for homeowners.

Currently, owners can deduct the interest they pay on their mortgage loans but not the cost of mortgage insurance premiums. Supporters of this new legislation say the new law would help level the playing field for low- and moderate-income buyers, who are the most likely to need mortgage insurance.

Traditionally, lenders have required that home buyers pay for private mortgage insurance if they put up a down payment worth less than 20 percent of purchase price.

Mortgage insurance typically costs about half of 1 percent of the mortgage. On a $400,000 loan, for example, the annual cost would be about $2,000. The mortgage insurance protects the lender in case the borrower falls into delinquency and defaults on the loan.

In recent years, many home mortgage lenders have helped buyers avoid mortgage insurance premiums by arranging so-called piggyback mortgages.

As a result, a borrower who can make a 5 percent down payment might take out a first mortgage for 80 percent of the purchase price, and a second mortgage loan for the remaining 15 percent – in effect substituting the second mortgage for much of the traditional down payment.

One drawback to the piggyback mortgage strategy is that lenders typically charge sharply higher interest rates for the second mortgage loan.

Under the new law, home buyers whose adjusted gross income is $100,000 or less could write off all the premium costs. Buyers with income between $100,000 and $110,000 would get to deduct a portion of the costs.