The 2007 tax law provides mortgage insurance premiums. While President Bush signed into law the Tax Cuts and Health Care Act of 2006, mortgage insurance premiums were not tax-deductible. From January 1, 2007, borrowers can now deduct these payments. On the surface, that sounds like good news for first time home buyers. But isn’t it?
One of the driving forces behind picking up spicy loans, also called compound loans, was a tax break available to pay all that interest versus paying a mortgage insurance premium that was not deducted from a single loan tax.
Another benefit is that total payments on a combo loan are often much lower than payments with PMI.
How Combo Loans Work
Combined loans or loans are financing that combines a first mortgage with a second mortgage (with or without a down payment).
The reasons why these types of loans are attractive are because many homebuyers do not have 20% of the purchase price in cash or do not want to lower 20% to buy a home – and combined loans increase the PMI obligation to pay. Common types of combo loans are:
- 05.15.80. This scenario involves a 5% reduction and first mortgage financing of 80% of the purchase price, together with a second mortgage of 15% of the purchase price.
- 10/10/80. This scenario involves a 10% reduction and financing of the first mortgage of 80% of the purchase price, together with the second mortgage consisting of 10% of the purchase price.
- 80/20. This scenario involves placing zero and financing the first mortgage of 80% of the purchase price, together with the second mortgage accounting for 20% of the purchase price.
Interest rates on the second mortgage are higher than those on the first mortgage, but sometimes the total payments are less than those financed on the first mortgage with private mortgage insurance.
Moreover, since combined loans peaked in 2005, many borrowers are considering other options because of short-term interest rate fluctuations.
Comparison of PMI and Combo Loans
Let’s compare two borrowers with an identical FICO number of 680. Here’s how the numbers work:
Let’s say the Good Finance family is buying a USD 500,000 home using 80/20 financing. The first mortgage would be 6.25% and be paid at USD 2,462.87 per month for principal and interest. The second mortgage would be 8.5% and be paid at USD 768.91 a month, principal and interest.
Total Payments for Combined Loan: USD 3,232
100% with PMI
But the Romulan family is buying a USD 500,000 home using 100% financing with PMI insurance. The first mortgage would also be 6.25%, payable at USD 3,079, with PMI insurance adding another USD 400 to that payment.
Total payment for the first mortgage with PMI: USD 3,479.
The Romulan family has to wait two years and get an estimate to show 20% of the share capital to get rid of insurance. But they say Romulans do, and the payout drops to USD 3,079 without PMI. The Romulans would not have paid less than Good Finance by the month of 63 AD.
Characteristics of Income Tax for MMI / PMI
MMIs are paid on FHA, Rural Home Loans, and some conventional loans require Private Housing Insurance (PMI), both of which are deductible under certain provisions:
- The tax relief and health care provision for PMI tax deductions applies to financing after December 31, 2006. This means homeowners can deduct mortgage insurance on loans taken in 2007. Even better news is the fact that under the name Mortgage Forgiveness Debt Relief Act of 2007, the PMI tax deduction was extended to 2010.
- They are available for individuals submitting joint or individual returns with less than USD 100,000 Adjusted Gross Income (AGI) or USD 50,000 for affiliates submitting separately. Most people have to earn at least USD 50,000 to take a better vacation than taking a standard deduction, so this pretty much lowers the qualifications for those earning over USD 50,000 and less than USD 100,000.
- Families earning above USD 110,000 AGI cannot deduct. But for those earning between USD 100,000 and USD 110,000 AGI, the phase deduction comes out 10% to USD 1,000.
- The deduction is available in refinances if the original loan amount does not increase. Pay your loan fees on credit, and you are likely to exceed your original balance and not qualify.
Experts anticipate another renewal of the provision based on the following:
- Mortgage insurance tax deductions end in favor of taxpayers.
- Reservations are well received by home buyers.
- Being able to foreclose on mortgage insurance helps more homebuyers buy first-time homeowners.