PMI is NOW Tax Deductible
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.
Posted: January 9th, 2007 under General Real Estate.
Tags: High-Rate-Seconde-Mortgages, PMI-Tax-Deductible, Private-Mortgage-Insurance, Tax-Law-Changes
About the Author: Ardell DellaLoggia
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Comments
2.
Comment
from Rhonda Porter
Time January 9, 2007 at 4:45 pm
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
3.
Comment
from ARDELL
Time January 9, 2007 at 4:55 pm
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.
4.
Comment
from ARDELL
Time January 9, 2007 at 5:04 pm
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.
5.
Comment
from Tim
Time January 9, 2007 at 5:23 pm
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.
6.
Comment
from ARDELL
Time January 9, 2007 at 5:29 pm
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?
7.
Comment
from Rhonda Porter
Time January 9, 2007 at 5:31 pm
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.
8.
Comment
from Rhonda Porter
Time January 9, 2007 at 5:35 pm
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.
9.
Comment
from Tim
Time January 9, 2007 at 5:43 pm
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 
10.
Comment
from Rhonda Porter
Time January 9, 2007 at 6:33 pm
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!
11.
Comment
from Anne
Time January 9, 2007 at 7:02 pm
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).
12.
Comment
from Michael
Time January 9, 2007 at 7:44 pm
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
13.
Comment
from ARDELL
Time January 9, 2007 at 8:39 pm
I’m pretty close to saying “sorry I asked” LOL
Thanks everyone! Great info in this string of comments!
14.
Comment
from Iconoclast
Time January 9, 2007 at 9:55 pm
Seems like a great time to buy a house now that PMI is tax deductible!
15.
Comment
from ARDELL
Time January 9, 2007 at 10:12 pm
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.
16.
Comment
from Rich Jacobson
Time January 9, 2007 at 11:44 pm
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!…
17.
Comment
from ARDELL
Time January 9, 2007 at 11:48 pm
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?
18.
Comment
from Michael
Time January 10, 2007 at 8:03 am
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
19.
Comment
from Jay T.
Time January 10, 2007 at 5:20 pm
Wow, what a great post and commentary. Thanks for sharing!
20.
Pingback
from PMI is Tax Deductible at The Phoenix Real Estate Guy
Time January 10, 2007 at 5:35 pm
[...] And a great place to start is over at Rain City Guide where Ardell and lender Anne Brown chime in, and others followed with great comments. Read it and start absorbing. [...]
21.
Comment
from dolka
Time March 23, 2007 at 1:32 pm
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
22.
Comment
from ARDELL
Time March 23, 2007 at 2:08 pm
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?
23.
Comment
from Rhonda Porter
Time March 23, 2007 at 3:47 pm
0.125 to 0.25 (depends on pricing that day/moment). 
24.
Comment
from Rhonda Porter
Time March 23, 2007 at 3:49 pm
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.
1. Comment from Adrianna
Time January 9, 2007 at 4:00 pm
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.