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January 6th, 2012

The MI tax deduction is on the chopping block

by Peter Miller

 

chopping blockUnless Congress changes the tax rules this year, mortgage insurance could become both more expensive and less desirable, something that would hurt the housing market nationwide.

Under current tax rules, the cost for mortgage insurance–whether it is through the FHA or through the private sector–is deductible to homeowners. For instance, if you pay $1,500 in mortgage insurance this year and are in the 25 percent tax bracket, your taxes would be reduced by $375. However, under the current rules, the mortgage insurance deduction will end this year.

L. Gaye Torrance, with the Mortgage Insurance Companies of America (MICA), said the association “is hopeful that Congress will address this issue in early 2012. The situation affects all low down payment mortgage borrowers, including FHA loans, which therefore impacts all homebuyers.”

Some history

“The tax deduction was first approved by Congress in late 2006 and applied to loans with mortgage insurance that closed in 2007,” according to MICA. There were two basic reasons for the relatively new write off.

One: Congress wanted to encourage homeownership in general.

Two: There was a disconnect in the marketplace.

Prior to the mortgage meltdown, lenders allowed borrowers to buy with little down and not pay any mortgage insurance. This was done by increasing mortgage rates, creating a higher monthly payment. With the higher payment, the lender would use the additional funds to self-insure the loan. The higher interest rate allowed borrowers to effectively write off the cost of mortgage insurance because they had a higher “interest” cost.

In other words, something called “interest” was deductible before 2007, while something called “mortgage insurance” was not, even though they were supposed to be the same thing.

While mortgage insurance companies are regulated by the states and required to have substantial reserves, lenders charging more interest did not have to abide by the same state regulations because they were not selling mortgage insurance.

What is mortgage insurance?

Mortgage insurance allows buyers to purchase real estate with less than 20 percent down. Insurance is available through the FHA, VA and private mortgage insurance (MI). MI coverage is funded with insurance premiums, typically an upfront premium paid at closing and then an annual premium based on the outstanding loan amount.

According to the National Association of Realtors’ 2011 Profile of Home Buyers and Sellers, the typical first-time buyer purchased with 5 percent down while repeat buyers had a 15 percent down payment.

It’s easier to cancel MI as opposed to a higher interest rate

FHA and private mortgage insurance can both be canceled. This happens with some exceptions once the loan balance is reduced to 78 percent of the original mortgage amount. According to MICA, “90 percent of borrowers cancel their PrivateMI within 60 months.”

In contrast, the only way to cancel a higher interest rate is through a refinance, and we all know how hard it is to be approved for a refinance.

Looking forward, it’s likely that Congress will continue the mortgage insurance deduction if only because the political cost of cancellation is too great. That said, an extension of the write off still has not happened yet.

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5 Responses to “The MI tax deduction is on the chopping block”

  1. Could Mortgage Insurance Deductions Bite the Dust? | Houston Agent Magazine Says: January 6th, 2012 at 3:01 pm

    [...] The mortgage insurance tax deduction, a commonly-used feature that can save homeowners to the tune of hundreds of dollars a year, could be a thing of the past, according to a new piece by HSH. [...]

  2. Could Mortgage Insurance Deductions Bite the Dust? | Miami Agent Magazine Says: January 6th, 2012 at 3:02 pm

    [...] The mortgage insurance tax deduction, a commonly-used feature that can save homeowners to the tune of hundreds of dollars a year, could be a thing of the past, according to a new piece by HSH. [...]

  3. Chicago Agent Magazine » Blog Archive » Could Mortgage Insurance Deductions Bite the Dust? Says: January 6th, 2012 at 4:02 pm

    [...] The mortgage insurance tax deduction, a commonly-used feature that can save homeowners to the tune of hundreds of dollars a year, could be a thing of the past, according to a new piece by HSH. [...]

  4. s2kreno Says: January 12th, 2012 at 1:14 pm

    Well, if that happens, expect a resurrection in lender-paid premiums, which are offset by a mortgage rate increase, which is tax deductible. This is the stuff that makes the BMW payments for CPAs and tax attorneys.

  5. Tim Manni Says: January 12th, 2012 at 1:36 pm

    Reno,

    Haha, thanks for your comment. What’s your expectation for mortgage rates as 2012 progress–what kind of increase are you expecting? I think most agree that mortgage rates will end the year a decent bit higher than they are right now, but how much higher?

    Thanks,
    Tim

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Tim Manni is the Managing Editor of HSH.com and the author of their daily blog, which concentrates on the latest developments in the mortgage and housing markets.

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