Mortgage Insurance: Tax Deductible, Popular

Slowly but surely, mortgage borrowers seem to be discovering that their mortgage insurance premiums will be deductible for the 2007 tax year.

According to the Mortgage Insurance Cos. of America, a Washington, D.C.-based trade group, more borrowers in each of the first three months of the year have turned to private mortgage insurance to help buy or refinance their homes than in the previous month.

There was a 55 percent increase in the number of mortgage refinance and home purchase loan applicants opting for PMI in March alone.

Similar data from FHA loans only a slight upswing. But it is early yet in the spring home-buying season, and folks are still finding out about the benefit lawmakers bestowed upon them late last year.

Of course, there are a lot of other things at play here, too.

U.S. mortgage lender underwriting standards are tightening and many who catered to borrowers with less-than-great credit during the buying binge are teetering on the brink of disaster.

But almost certainly, the fact that, for first time, mortgage-insurance premiums on conventional mortgage and government loans can be written off on next year’s tax return has had a big impact.

“We don’t track why consumers and lenders elect to use mortgage insurance,” says Lisa Rambler, senior vice president of marketing and product development for AIG United Guaranty in Greensboro, N.C.

“But we have heard anecdotally from several lenders that more and more borrowers are using MI [mortgage insurance] because of the tax write-off.”

Mortgage insurance is required by a home loan lender who is willing to allow borrowers to put up less than 20 percent of the purchase price or, in the case of owners wishing to refinance, 20 percent of the home’s appraised value.

Actuarial studies have shown that the less skin borrowers have in the game, the more likely they are to default on their monthly house payments.

But because it is so difficult and time-consuming for most people to come up with enough money for a standard 20 percent down payment, lenders accept mortgage insurance as a substitute for a lack of cash.

The task of saving for a down payment is tough on first-timers.

Unlike repeat buyers, who often can avoid mortgage insurance by using some or all of the home equity they have built up in their current residence to meet the 20 percent threshold, rookies have to scrimp and save every nickel they can get their hands on - or borrow from friends and relatives.

While coverage protects lenders against the possibility that the borrower will not make his payments as promised, it is the borrower who pays the freight. And it isn’t cheap.

The cost varies widely, depending on a number of factors: How large - or small - the cash down payment, the type of mortgage and the amount, or “depth,” of coverage required by the mortgage company.

On a single-family home at the median price of $224,500, the cost of private-insurance coverage ranges from $50 to $100 a month.

Often the fee is so expensive that lenders recommend taking out two loans, a primary mortgage at 80 percent of the home price and a second mortgage at a somewhat higher rate to cover the difference between the 20 percent down payment and the amount of cash the borrower can put into the deal.

These so-called “piggyback” loans can sometimes be cheaper than mortgages with insurance because interest on both loans is tax-deductible. But they have their drawbacks, too.

They require two closings, so settlement fees are higher. And they must be paid back in full. They cannot be canceled like mortgage insurance, which can be jettisoned when the difference between the outstanding loan amount and the current value of the property reaches a certain point.

Of course, the best way to determine which product is best for you is simply to do the math. But this year, anyway, part of the equation involves the ability to write off a portion of your mortgage-insurance premiums.

That might not be as great as it sounds, however. For one thing, it’s not a dollar-for-dollar write-off. Like mortgage interest, it is a “below the line” deduction based on your tax bracket.

So, if you are in the 31 percent bracket, your tax benefit is only 31 cents on every dollar of insurance premium. For another, you can only claim the write-off using an itemized return.

Most homeowners do, because the tax-deductible home loan interest and property taxes they pay are usually greater than the standard write-off. But if the standard deduction is more beneficial, the MI deduction is useless.

And one more thing: The deduction is limited to borrowers with adjusted gross incomes of $109,000 or less.

You will be eligible for the full deduction if you earn $100,000 or less of your AGI, which means your family’s gross earnings, less adjustments for tax-deductible IRA contributions and interest on student loans.

But for every $1,000 of income above the $100,000 threshold, your write-off for mortgage insurance will be reduced by 10 percent.

Despite this, the average annual savings for taxpayers taking mortgage-interest write-offs will be in the $300 to $350 rang.

There are a few other qualifications worth mentioning as well:

• The write-off applies only to mortgages on a principal residence and one vacation property held for the personal use of the taxpayer for 14 days or 10 percent of the days it is rented, whichever is greater.
• It applies to mortgage refinancing up to the original loan amount. This could include first and second mortgages but not cash-out refinances.
• When refinancing a piggyback loan, the original loan amount is considered the sum of the first and second mortgages.
• It applies to move-up borrowers, not just first-timers. But investor home loans are not eligible.
• There is no loan limit. The only ceiling is on the taxpayer’s income.
• The deduction does not apply to lender-paid mortgage insurance in which the premiums are built into the interest cost of the loan.
• The cost of LPMI is already deductible as interest.

SOURCE: Orlando Sentinel