Ethical Homes

As part of the most recent Omnibus tax bill, Congress quietly approved making buyer-paid PMI tax-deductible.

The deduction, which goes into effect as of January 1, 2007, would apply for buyers whose total household adjusted gross income is less than $100,000/yr. Fannie Mae and Freddie Mac require that all loans that conform to their underwriting guidelines (and that thus get the best rates) not exceed a loan-to-value ratio (aka LTV—the ratio of the amount borrowed to the appraised value of the home) of 80%; borrowers whose loans that exceed that LTV have to pay an extra monthly premium in the form of PMI, or Private Mortgage Insurance, which covers the lenders against the greater risk that they face from those higher LTV loans (since borrowers with less than 20% equity in their home are, statistically, more likely to be willing to declare bankruptcy or otherwise abandon their home if times get tough financially). Especially as borrowers discovered that they could purchase homes with less than 20% down (sometimes as low as zero-down!), borrowers with less than 20% of the home’s value available to use as a down payment have tried to avoid PMI by getting a “piggyback” loan, where they have a first loan for 80% of the value of the home, and then a second loan covering the difference between 20% of the value of the home and the amount of the downpayment.

Those second mortgages usually have much higher rates than the first mortgages—not coincidentally, the higher rates usually result in a total monthly payment for both loans of about what the borrower would have paid with a single loan plus PMI—but the “traditional” wisdom (which I never found very wise anyways) was that the two mortgages were still preferrable because the interest on the second loan is tax deductible, while PMI historically hasn’t been.

Now that PMI has the same tax advantages as a piggyback mortgage, though, it hopefully will become more obvious to buyers that they really need to run the exact numbers to see which type of loan saves them the most money, rather than using a generic rule of thumb that is often incorrect. (Also, it’s worth noting that PMI can be removed from your loan once your equity reaches 20% of the original loan amount, while a second mortgage is only removed once you’ve paid it off—in an appreciating housing market, your equity in the house will reach 20% well before you’ve paid 20% in down payment plus principal payments on your loans; buyers really need to include things like current market conditions and how long they plan on staying in a particular home or loan in their decision making process, since that can make a big difference in which loan to obtain.)

Are you wondering whether to go with two piggyback loans or single loan with PMI? Contact us now and we’d be glad to set up a free, no-obligation consultation with you to go over your entire situation and help you decide what type of loan program is best for you.