The MI tax deduction is on the chopping block
by Peter Miller
Unless 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.
