THE BASIS POINT

What Is Mortgage Insurance? And Is It Tax Deductible?

 

If you’re a homebuyer with less than 20% down, let’s say 10% down as an example, you’ve probably heard over the past several years that you just get a first mortgage for 80% and a second mortgage for the remaining percent. This way, you avoid mortgage insurance lenders charge for first mortgages above 80% of the home’s value. But as the market for high loan-to-value ratio second mortgages tightens up, we’re returning to the mortgage insurance lending models of old.

Prior to the last lending crisis in the 1980s, there were no second mortgages, and down payments were mostly 20%. As higher loan-to-value ratios became more commonplace, mortgage insurance did also, but then the market for second mortgages grew as a way to get around paying mortgage insurance. Mortgage insurance is simply a risk premium that lenders charge for a loan above 80% loan-to-value. Below are some notes about the types of mortgage insurance, how it’s calculated, and how loan approvals are affected by mortgage insurance (MI).

HOW IS MORTGAGE INSURANCE CALCULATED?
There are two types of MI. First, for typical conforming loans up to $417,000 (and now even up to $729,750 with higher conforming loan limits in place), MI is about 60 basis points of the loan amount per year. It’s charged until you reach 80% LTV, then it can be cancelled. So if you were buying a home for $463,000 with 10% down and financing 90% (a loan of about $417,000), your monthly MI would be calculated like this: ($417,000 x .6%)/12 = $208.

This can be a tax deduction if your adjusted gross income (AGI) is $109,000 or less. But there’s also something called lender paid mortgage insurance (LPMI) which is when you take a higher mortgage rate in exchange for having the mortgage insurance included in the loan amount. If your AGI is greater than $109,000 and you’re doing a loan with mortgage insurance, then LPMI is a way to optimize tax benefit because the mortgage insurance is expressed as loan interest which is deductible. Always consult a tax professional to verify parameters of mortgage insurance deductions and whether you qualify.

The second kind of MI is on FHA loans, which are also available up to $729,750 depending on median price in your zip code (until 12/31/08, but higher loan limits for FHA and conforming will likely be extended–look up conforming/FHA limits by zip code here). There are two tiers of FHA mortgage insurance: (1) An up front MI fee of 1.5%, which can be, and most of the time is, financed, and (2) annual MI of .5%.

So in the same $463,000 home purchase scenario above, your monthly MI would be $174 and your up front MI would be $6255, which can be paid up front or added to the loan amount. If added to the loan amount, it would change your monthly payment by $39. FHA MI on 30yr fixed mortgages must be held for 5 years before cancellation, and you must be at a 78% loan-to-value ratio to cancel. When you do, FHA will also evaluate your situation and refund a prorated portion of the up front MI.

It’s also worth noting that FHA loans allow for down payments as little as 3%. This makes them a viable loan product for borrowers who have the income to be able to afford a home but are light on cash.

HOW LOAN APPROVALS ARE DIFFERENT WITH MORTGAGE INSURANCE
For FHA loans, mortgage insurance is standard and it’s done through the Federal Housing Administration. So the loan approval process from a consumer standpoint is normal.

For conforming loans with mortgage insurance, there are 2 layers of loan approval. The loan goes through the typical bank underwriting process: your income, down payment, assets, debts, and credit scores are analyzed, the property value is analyzed, and then you’re approved based on the outcome of that analysis. Simultaneously, all of those things are also reviewed by a third-party mortgage insurance comapny. Both approvals are required for your loan to fund. To the consumer working with an experienced mortgage provider, this should feel like one process, but this is just background on the process.

There’s been speculation about the viability of mortgage insurance companies hit by excessive foreclosures. This is an industry issue that’s being monitored along with the viability of conforming mortgage backers Fannie Mae and Freddie Mac, but from a consumer standpoint, there are thousands of loans with mortgage insurance being approved every day, so again, the loan approval process should feel normal.

 

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