Mortgage Insurance Premiums Tax Deductible in 2007!

In the final hours of the 2006 session, Congress passed a law that will drastically change the tax code. According to the new law, private mortgage insurance premiums will be tax deductible in 2007 for households earning up to $110,000 annually. According to Mortgage Insurance Companies of America, Inc., this law could save homeowners $300 to $500 a year in taxes.

Lenders require private mortgage insurance (PMI) when buyers pay less than 20 percent as the down payment on a home. Mortgage insurance protects the lender against financial loss should the buyer default on the loan. It also allows the buyer to purchase a home with little or no down payment, or to refinance at “loan-to-value” ratios higher than 80 percent. The cost of mortgage insurance is typically one-half of 1 percent of the home mortgage, or $83 a month for a $200,000 loan.

Because PMI premiums, historically, have not been tax deductible, many consumers have turned to the "piggyback" loan strategy. To set up a "piggyback" loan, the buyer secures a first mortgage at 80 percent of the home’s value--therefore not requiring mortgage insurance--and then takes out a second loan to get the additional funds needed to finance the home. This second mortgage is "piggybacked" behind the first, allowing the interest on both loans to be tax deductible.

Interest rates on these second home loans have risen dramatically in recent years, since most are tied to the federal funds rate. The Federal Reserve Board has made seventeen .25 percent rate hikes since June 2004, for a total increase of 4.25 percent! And although the Fed is currently in a "paused" mode, there is debate as to whether or not the Fed is done hiking rates just yet. During this same period, PMI premiums have remained about the same.

Once the president signs this new law, mortgage options that include standard private mortgage insurance will now become more competitive and attractive. Although the initial payment with a PMI premium might be slightly higher when compared to the "piggyback" option, remember that mortgage insurance can be removed in time, with property appreciation or a declining loan balance, as long as home owners pay their premiums in a timely manner. In addition, mortgage payments may be lower (especially since there will interest on only one loan) and there will be only one mortgage bill to pay each month.

It’s important to note that this new law applies only to loans that close in 2007. Also, the law allows for the full tax deduction to be taken only if the buyer’s adjusted gross income is $100,000 or less. Smaller deductions are allowed for those with an income up to $110,000. PMI tax deductions are not allowed if the buyer’s adjusted gross income exceeds $110,000.

***Please remember that whenever the IRS is involved, it always makes sense to review the specifics with a tax professional.***