New tax deduction created for mortgage insurance
insurance will be tax-deductible in 2007. For some homeowners,
the new law means it will cheaper to get mortgage insurance instead
of getting piggyback loans.
The 109th Congress passed the tax law in its final
hours. Hundreds of thousands of homeowners will save a total of
$91 million when they file their tax returns in 2008, according
to estimates prepared by the mortgage insurance industry.
"This is really going to help close to a million
Americans who will buy a home next year using mortgage insurance,"
says Kevin Schneider, president of U.S. mortgage insurance business
for Genworth Financial.
Bottom line for consumers: Don't get a piggyback loan
without taking a serious look at mortgage insurance, because mortgage
insurance is likely to be cheaper in the long run, and it might
even cost less in the short run.
According to an analysis by Bankrate, a homeowner
with a $180,000 mortgage would save about $351 in taxes per year
because of the law. That assumes that the borrower has good credit
and is in the 25 percent tax bracket.
How mortgage insurance works
When you buy a house, lenders consider you a riskier borrower if you make a down payment of less than 20 percent. There are two main ways to make you pay for that risk: mortgage insurance and piggyback loans.
Mortgage insurance is the old-school method. You,
the borrower, pay for the policy, but the lender is the beneficiary.
If you fall behind on the loan payments and the lender has to foreclose,
the mortgage insurance policy reimburses the lender for legal costs
and lost income. The premiums depend on the size of the loan, the
percentage of the down payment, your credit score and the type of
mortgage insurance you get (private, from a number of companies,
or public, from the Federal Housing Administration, Department of
Veterans Affairs or Rural Housing Service).
How piggyback loans work
Piggyback loans are the new-wave method of dealing with a down payment
of less than 20 percent. When you use a piggyback, you get two home
loans: a primary loan for 80 percent of the house's value and a
second mortgage for the rest of the money you need. With a 5 percent
down payment, you would get what's called an 80-15-5 mortgage: an
80 percent loan, a 15 percent piggyback and the 5 percent down payment.
Getting a piggyback eliminates the need for mortgage insurance.
The piggyback can be either a fixed-rate home equity loan or a variable-rate home equity line of credit. The piggyback has a higher rate than the first mortgage.
The combined payments on a piggyback mortgage are a bit less than the payment on a single loan with monthly mortgage insurance premiums. For years, piggybacks had a big advantage because the mortgage interest on both loans was tax-deductible, while mortgage insurance payments were not. Now that has changed, with caveats.
When you put those complications aside, the new law
makes it easier to compare loan offers, says Mike Zimmerman, vice
president of investor relations for mortgage insurer MGIC. "Now
everything's on an equal footing: Mortgage insurance is tax-deductible
and piggyback is tax-deductible."
Pay more now or later
Zimmerman says that in many cases, monthly payments on a loan with mortgage insurance will cost more than piggybacks, even after the tax deduction is taken into account. That makes them more expensive in the short run. But private mortgage insurance can be canceled on loans more than two years old if the home's value has appreciated enough for the owner to have more than 20 percent equity. In contrast, you can't cancel a piggyback loan. You pay it until it's paid off.
When deciding between getting a piggyback or mortgage insurance, you have to guess how long you will have the loan. If you think you'll move or refinance within two or three years, it's best to go with the option that provides lower monthly payments. But if it's a fixed-rate loan that you'll keep for five or more years, it's probably going to be cheaper in the long run to get mortgage insurance because you can cancel it.
Ask your lender to compare the total costs for piggyback and mortgage-insured loans over the first one, two, five and 10 years, or try out the calculators available on the Web sites of mortgage insurers Genworth, MGIC or PMI Group.