[photopress:Anne_business_card_pic.JPG,thumb,alignright]My friend and colleague (disclosure) Anne Brown of AB Homelending and I have been discussing the fact that PMI is now tax deductible. Here are her thoughts:
“It’s taken a long time, but finally Private Mortgage Insurance (PMI) is tax deductible. A loan over 80% loan to value (less than 20% down payment) is required to have PMI unless the loan is split into a 1st and 2nd mortgage. Until recently, the additional cost of this insurance was not tax deductible. This is Great news, but proceed with caution…
Here are my two cents: If you take a loan with PMI then the question is what will the investor or PMI company accept for an appraisal to prove the 20% equity. Obviously their motivation is to A) be protected and B) make money (respectively). From previous experience I’ve seen in-house appraisals come in lower than market value so be aware that there is a factor of lack of control for removal of the PMI. Who would want to be stuck with the PMI if the new value is challenged? Just my thoughts. Anne Brown”
Unfortunately her thoughts raise more questions than they answer! LOL So I thought maybe we could have a discussion here and invite other lenders and accountant types to comment on this important topic.
My thoughts (Ardell speaking here, not Anne)
Back in the old days, when I started in real estate, it was common for the first mortgage to be 95% with 5% down at one low rate. The monthly payment included the PMI charge, which was not tax deductible. PMI being Private Mortgage Insurance insuring the lender on th 95% financing loan for the amount above the 80%…in this case 15%.
Today, instead of PMI, most borrowers get a first mortgage for 80% at a LOW rate and a second mortgage at 15% at a HIGH rate in order to avoid PMI.
The question of the day therefore is, when is the buyer better off WITH the PMI instead of the HIGH RATE second? At least that is MY question of the day. How does a buyer evaluate which would be better in the long run for them? I expect the high rate second was cheaper before this news that PMI is tax deductible, or so many would be going that route. Does this news change that? If so, does it change it for everyone…or only people in very high tax brackets?
A tough topic…but an important one. Hope those who know more on this will comment freely to the enlightenment of us all.
Thanks.
Since I was the one who alerted Anne to this and am currently wrestling with this question, I’ll tell you how I see it. We are in the position of either taking a $40,000 second mortgage of 10% at an 8% rate, or getting PMI, on a $404,000 purchase. Since we plan to improve the house in question to gain some immediate equity and it’s forecasted that the Seattle area will appreciate 5% a year, I feel pretty safe in thinking we could get our 10% equity in 2 years. NOW – the second mortgage will cost us $296 a month, plus we have additional closing costs of $850. With PMI, we’d have a 90% loan at 6% plus PMI of $153. So our monthly payments are $60 higher with PMI, but if we reach 20% equity in 2 years and can then cancel it, we’ll be SAVING $100 month over the second mortgage. As near as I can figure it, going with PMI will cost us only $400 more total if we can cancel it then, PLUS we’ll have just one loan at 6%. Seems like a clear winner, though of course it does all hinge on the lender cancelling the PMI. I can be pretty annoying when I need to be. 😉
Hi Ardell,
It all depends on the buyers situation and future plans. If they are going to have a bonus in the future or come into money and want to pay off the second mortgage, then the second mortgage may make more sense. I’ve found that it’s not always easy to remove PMI once you have it. The burden is on the borrower to prove they no longer need PMI.
Another consideration is if borrowers have an adjusted gross income over $100,000, then they do not get the benefit of deducting PMI on their taxes.
A product very much worth considering for buyers with less than 20% down is LPMI (Lender Paid Mortgage Insurance). The rate is slightly higher as the PMI is financed into the rate. Some lenders offer very competitive rates with the LPMI product and the interest is tax deductable.
Just my 2 cents!
Rhonda Porter CMPS
Thanks Rhonda,
I think from my perspective, abuses and predatory lending are more pronounced in “sub-prime lending shops”. I would rather see people getting first mortgages from reputable lenders and PMI and close out the 2nd mortgage market.
That is a perception of mine, not my field obviously. Is my perception incorrect? It seemed the lending industry was “cleaner” with first mortgages and PMI, than it is today.
Adrianna!! I didn’t see you up there. WOW! Where do I start?
OK, getting rid of PMI takes me back to the old days when everyone had it, and it was NOT easy to get rid of. If getting rid of it requires a refinance with no PMI on the new loan…you have your closing costs all over again. And I do think that is “how” you get rid of it in two years in your scenario.
I like the bigger first mortgage with one low rate for a lot of reasons and will look into converting mine. However, everything I know about PMI (which is out of date) suggests that you must pay off that percentage of your principal, and not simply prove that the value increased (because it can also decrease). Dem was da rules for many years…there have been changes.
So before you assume you can get rid of PMI, make sure that is without refinancing the entire loan, which can be quite costly.
For consumers, I think it boils down to affordability (qualifying) and the consumers appetite for risk vs. return and potential tax benefit of PMI being tax deductable (during the PMI period). Adrianna above is counting on 5% appreciation per anum over a two year period to allow for the removal of PMI and having more equity due to home improvements as an additional benefit.
Generally, I mention risk and affordability because many borrowers have piggy back loans of various degrees (80-20, 80-10-10, etc.) to eliminate the PMI issue due to qualifying issues—getting debt ratios in order,for example. On the other hand consumers have to realize that the risk associated with these scenarios is real. For example, we’ve witnessed over the last year where rates on HELOC’s (a popular method of 2nd loans) have increased, thus increasing the monthly payment—something that most consumers may be MUCH more sensitive to than the end of year tax benefit of PMI deductions.
It will be interesting to see if there is much of a market shift back to PMI due to the tax deduction as a sole reason. Obviously the market lenders/brokers make money off of producing 2nd mortgages and HELOC’s. Not a dig at the situation, just a fact.
Tim
Good point..WHY would anyone use a HELOC for a seconed? What’s the rationale there. I have had a lot of clients doing 100% financing without fluctuation rate HELOCs. Who is pushing them and what is their perceived advantage?
That’s a tricky one! My background, before lending, was in the title and escrow industry (14 years) and I thought there were some pretty interesting characters back then. I have only been a Correspondent Lender (kind of a combo between a banker and a broker) for my entire lending career of 7 years. When we utilize PMI products, the loan is underwritten outside of our company at the PMI company vs. underwriting “in house” with our underwriter.
Second mortgages have come along way as well in just the time I’ve been in lending. It does depend on what lender you work with. The second mortgages that are piggy back that I provide are from “reputable lenders”.
You are correct that there is a second mortgage market that is not what I would call “cleaner”…in fact, I would call it sub-subprime. I honestly refuse those loans, they are a foreclosure waiting to happen. It’s a real lose lose for all. I’ve seen those situations pop up more from “stand alone” seconds than in a purchase money scenario.
I’m generally opposed to HELOCs as well. Especially when purchasing as the payment is not fixed. HELOCs, I feel, are most appropriate as a financial planning tool (just to have available in case of an emergency and NOT to use…but who does that?). It takes a very disciplined person to not use their HELOC.
Clients are usually interested in HELOCs due to the interest only aspect. Once they learn the lifetime cap is 18% (with no annual or monthly caps), they typically change their minds…and for good reason.
Rhonda – Thanks for the perspective. Cool that you have been in the escrow end of things. It’s a little lonely around here with little to no commenting from other escrow and title folks. Yep, you see a LOT of things.
Rhonda, how long do you give us in escrow—before we go into lending! Been in it for 3 yrs going on 10! LOL 🙂
Tim – It’s been so long since I’ve worn the title/escrow hat… I’m thankful that I’ve had that experience to add to my perspective.
You’re funny!
Ardell brings up a good question here. There is no clear solution that fits
every situation. Here is a bit more on PMI and how it works: PMI is
calculated based on the entire loan amount, not just the portion over 80%.
PMI also uses a graduated rate scale based on the amount over 80% you are
borrowing, the more you borrow the higher the rate. Without getting too far
into the math a $400,000 loan at a 95% LTV would require a separate PMI
payment every month of $250-350 (that is $3,000-$4,200/year) depending on
documentation type and credit score.
Another factor to remember is that the higher the LTV the higher the risk to
the instutition lending the money. Meaning there could be increased rules
for being approved for the loan. It is not uncommon to qualify for two
loans – a lower interest rate loan at 80%LTV and a second mortgage for an
additional 15% of the property value (95%CLTV) – but NOT qualify for one
loan at 95%.
One of the driving forces behind the deductability of PMI is the benefit to
lower income and lesser qualified borrowers who often had no choice but to
take PMI because they did not qualify for a second mortgage. Many argued it
was unfair for someone who has good credit (and more than likely a higher
income) to be able to deduct the interest on a second mortgage (receiving a
tax benefit) while someone paying PMI would not recieve the same benefit.
Each situation needs to be looked at carefuly with an experienced mortgage
consultant. A variety of factors including credit history, property value,
property location, and LTV need to be considered before jumping into PMI.
More often than not it is still less expensive and provides more flexibility for a borrower to have a second mortgage or Home Equity Line of Credit (HELOC).
I am assuming that credit scores and cash for a down payment and closing costs are not an issue and the buyer is interested in which loan scenario costs the least amount of money.
The accounting concept of substance over form says financial statements reflect the financial reality of the entity rather than the legal form of the transactions and events which underlie them. PMI may be insurance on the surface, but it is insurance to protect the lender paid by the borrower. From a finance (the descipline and not lending) and accounting point of view PMI is another cost of borrowing money similar to loan fees, discount points. PMI is interest. The after tax effective interest rates (similar to the calculation of APR) of each scenario need to be calculated and reviewed. The scenario with lowest after tax effective interest rate is the least costly.
Cheers,
Michael P. Lindekugel
Financial Analyst
RE/MAX Commercial
Team Reba – RE/MAX Metro Realty, Inc
I’m pretty close to saying “sorry I asked” LOL
Thanks everyone! Great info in this string of comments!
Seems like a great time to buy a house now that PMI is tax deductible!
I wouldn’t say that…many have not used PMI in years. I don’t think PMI being tax deductible is a reason to buy or not to buy a house.
Ardell,
As coincidence would have it, one of my valued numbers guys just posted on this very subject over on ActiveRain. I think Mark’s take will shed an interesting perspective on things!…
http://activerain.com/blogsview/32808/Grab-A-Calculator-And
Thanks Rich!
Excellent write up. I don’t like that “one year thing”. That puts a different light on it for sure! Is it a test?
http://activerain.com/blogsview/32808/Grab-A-Calculator-And
I agree with Mr. Flanders treatment of PMI as a cost of financing or interest. The calculation is flawed. The calculation should be calculated before tax or after tax, but not mixed for the same reason tax free municipal bond yields are compared to the after tax yield of taxable bonds for decisional analysis.
Fortunately, recalculating his example on a consistent basis won’t change the outcome that the 80%/20% loan has a lower effective interest rate on both an after tax basis and before tax basis. For a different set of loan terms as an example, mixing the tax treatment in the calculation with could result in an erroneous decision.
Cheers,
Michael P. Lindekugel
Financial Analyst
RE/MAX Commercial
Team Reba – RE/MAX Metro Realty, Inc
Wow, what a great post and commentary. Thanks for sharing!
Pingback: PMI is Tax Deductible at The Phoenix Real Estate Guy
I was offererd a 40 year mortgage. So far it looks like a good idea. However another bank told me they dont recommend them for their client. I am so confused as to what to do if to go with the 40 or do 30
Need the lenders to answer this one. Seems to me the 40 year will have a higher rate and a lower payment. When I saw the number on one, the savings per month didn’t seem to justify the extra 10 years of interest paid.
If you need the lower payment intitially, you can always pay the high monthly when you can afford it. Anyone can turn a 40 year loan into a 30 year loan by simply paying the 30 year payment on their 40 year loan, as I understand it. Question is, what is the difference in the annual rate of interst on the two products?
0.125 to 0.25 (depends on pricing that day/moment). 😉
Dolka, Ardell is correct that you can have a 40 year amortized mortgage and convert it to a 30 year by paying additional towards the principle. What ever mortgage product you select should be based on what your plans are with your current property (how long do you plan on retaining it) and what your personal financial goals are. There’s more to be considered than lowest payment and interest, etc.
We are doing a refi (jumbo FHA loan, LTV 95%) and are trying to renegotiate terms with the lender before our recission period expires.
We showed him an offer from another lender, and asked him to match it. (0.5% in points and a lower monthly payment). He states, that for various reasons his people want the loan to fund the way it was written (1.95% in points and a higher monthly payment) but that he will send us a cheque for the 1.9% difference in points that we can use to make a prepayment on the mortgage – and that after reamortizing this will lower our monthly payment to something similar to the offer that they are matching.
It is my understanding that a balloon payment will only create a lessening in the length of the mortgage – not a reduction in monthly payment amount.
Is this true?
Does the above all sound too, too shady?????
Help!
I would like to be notfied about followup comments regarding my mortgage funding issue via email, if possible
Kelly,
This was not likely a good place to put this question. The lender in this older post is no longer in the mortgage business. She got married and moved.
I will forward your question to Rhonda via email with a copy to you.
Kelly,
Ardell has access to your email address, the rest of the RCG writers do not.
Did you ask him to put that in writing?
If you are given a check at closing for 1.9%, sending that money to the lender as a principal payment generally does not result in a re-amortization of your entire loan balance….with the end result being a lower monthly payment. Instead you would just have a lower principal loan amount.
Typically if your loan is priced a certain way, you may be getting a certain interest rate because there will be “no cash back” to the borrower at closing. “Sending you a check” after closing means that this is being done without the lender’s approval.
You could also test him by asking for the “cash back” to be done through escrow and not outside of escrow.
If he insists it can’t be done this way for “various reasons” well you now know it’s because he is trying to hide this from the lender.
Remember that the company with the lowest points or rates may not offer the best service or other terms on your other fees.
Good luck with your refi!
PS. Your recision period happens AFTER you sign your final loan documents. It would be pretty nasty of you to recind the loan after you’ve already signed closing papers for a lower rate and fee.
Homeowners usually figure all this out way ahead of signing documents.
Jillayne,
Rhonda and I have conversed with Kelly via email per her request. I agree with you that the test is, why can’t it be a lender adjustment on the sheet?
“You could also test him by asking for the “cash back
Worth noting whether or not PMI is still deductible, since Kelly used this post to question other things. We might as well post an update on deducting PMI (Private Mortgage Insurance):
“Congress has extended tax deductions for homeowners paying private mortgage insurance through 2010. But to qualify for the deduction you must have bought or refinanced your home since Jan. 1, 2007. Families with adjusted gross incomes of up to $100,000 can deduct 100% of their insurance premiums, much the same as they deduct property taxes…”