Homeowners who are eligible to deduct the PMI premiums paid on a mortgage can shave hundreds of dollars off their income tax bills.
If you put down less than 20% on a house, expect to be required to purchase private mortgage insurance, which protects the lender in the event you default on the home loan. That's a good deal for the lender, considering you're the one paying the PMI premiums.
But PMI is also a good deal for aspiring homeowners. Many people, especially first-time buyers, can't come up with big downpayments. PMI encourages lenders to give them mortgages anyway.
Don't pay PMI a day longer than you must, however. Canceling the insurance as soon as you're entitled can save you thousands of dollars. For eligible homeowners, deducting the premiums come tax time can save hundreds more.
Getting the PMI tax deduction
Starting with loans issued or refinanced in 2007, and continuing through 2010, you can deduct each year's premiums paid on PMI for your principal residence and for a non-rental second home. The tax break was originally good for 2007 only, but the government extended it for three years. Unless it's extended again, you won't be able to take the deduction beyond 2010.
The deduction begins to phase out once your adjusted gross income reaches $100,000 ($50,000 for married filing separately) and disappears entirely at an AGI of $109,000 ($54,500 for married filing separately). In general, you can only deduct the premiums paid for the current tax year. If you pre-paid premiums for future years, that portion must be allocated to those future years. Rules can vary for mortgage insurance provided by the Federal Housing Administration, Department of Veterans Affairs, and Rural Housing Service, so consult a tax adviser.
To claim the PMI deduction, you must itemize you return. Enter qualified PMI premiums on Line 13 of Schedule A. The IRS instructions for Schedule A include a worksheet for homeowners subject to the income phase-out. Basically, you'll lose 10% of the deduction for each $1,000 over the $100,000 AGI limit you are.
How much can you save?
According to the Mortgage Insurance Companies of America, an industry trade group, PMI premiums on a median priced home ($198,100 in 2008) run between $50 and $100 per month. Justine DeVito Tenney, a CPA and financial planner with Weiser LLP in Lake Success, N.Y., says a good rule of thumb is $50 a month for every $100,000 of financing. The amount of the downpayment, type of loan, and lender requirements can all affect the actual cost.
United Guaranty, a PMI provider, offers an online calculator that estimates premiums based on various assumptions. Put 5% down on a $200,000 house, for example, and you'll pay monthly PMI premiums of about $150. Increase your downpayment to 10%, and you'll pay less than $100 a month.
How does all of this affect your tax bill? Let's say a married couple filing jointly with an AGI of $100,000 bought a house on Jan. 1, 2009, for $200,000. They put down 5%. By the end of 2009 they paid $1,800 in PMI premiums ($150 times 12 months). By reducing their $100,000 AGI by $1,800, they lower their tax liability by $438.
Automatic cancellation of PMI
While the tax deduction is nice, at least while it lasts, getting rid of PMI altogether is even nicer. The Mortgage Insurance Companies of America estimates that 90% of homeowners are done paying PMI premiums within five years of buying their homes.
If you bought your home after 1999 and are still paying PMI, you probably fall under the Homeowners Protection Act (HPA) of 1998. Your lender is required to automatically cancel your insurance once you've paid down your mortgage to a 78% (0.78) loan-to-value ratio, or LTV. Put another way, once you have 22% equity. Many lenders will treat pre-HPA loans in a similar fashion. Call to confirm.
To figure your LTV, divide the outstanding loan amount by the original price of your home. If you have a $190,000 mortgage on a house you purchased for $200,000, the LTV is 95%. You'd need to get the mortgage balance down to $156,000-78% of the original value-to qualify for automatic cancellation of PMI.
Requests for cancellation
You don't have to wait for automatic cancellation. When your LTV hits 80%, you can petition your lender to end PMI. The process can take several weeks. Your lender isn't required to oblige your request, but you'll bolster your case if you have a good payment history.
Start by calling your lender, not the PMI provider. You'll probably need to make a formal request in writing and pay out of pocket for an appraisal. While it's conducted primarily for the benefit of the lender to confirm that your property hasn't declined from its original value, a high appraisal can work to your advantage. As your property value increases, whether due to a general uptick in real estate prices or specific home improvements, your LTV decreases.
Tenney, the New York CPA, points out that even if you don't meet the 78% or 80% milestones, you can get PMI canceled when you hit the mortgage midpoint. On a 30-year fixed-rate mortgage, that would occur after 15 years of payments. This can come into play for certain high-risk loans that call for a longer PMI period.
Piggyback loans dodge PMI
Looking for a PMI loophole? Try so-called piggyback loans, also known as 80/10/10 or 80/15/5 loans. Basically, the home lender finances 80% and immediately gives you a second loan for another 10% to 15%. You put down 5% to 10%. No PMI is required.
This alternative has traditionally been available for homebuyers with minimal capital but excellent credit. In tight lending environments, however, this arrangement is harder to come by. And even when piggyback loans are available, the extra interest you usually pay on the second mortgage may actually cost more than PMI premiums.
This article provides general information about tax laws and consequences, but is not intended to be relied upon by readers as tax or legal advice applicable to particular transactions or circumstances. Readers should consult a tax professional for such advice, and are reminded that tax laws may vary by jurisdiction.
Richard J. Koreto is a freelance writer. He has been editor of several professional financial magazines and is the author of "Run It Like a Business," a practice management book for financial planners. He and his wife own a pre-Civil War house in Rockland County, N.Y