Q: I've always heard that private mortgage insurance (PMI) is not tax-deductible. However, a friend of mine told me it might be under limited circumstances. What's the real truth?
A: Normally, PMI is a non-deductible cost of owning a personal residence (much like homeowners association fees, insurance, etc.) However, Congress passed a bill in 2006 to have a one-time only deduction for PMI under very limited circumstances...
First, what is PMI? Traditionally, buyers of residences had to put 20% down and finance the other 80% with a mortgage. This is obviously a bit difficult to do now that houses can cost an average of $300,000. It simply would take too long for a married couple to save $60,000 in this case, especially considering that's about the equivalent of the median income for a family of four.
Since mortgage lenders want to make money, they came up with two solutions to this problem. The first solution is by far the most common--the "second trust" mortgage. Under this arrangement, some portion of the 20% down payment can be financed with a second mortgage. In the height of the housing speculation bubble, this second trust often covered all 20 percentage points (or more). Much more likely to re-assert itself, though, is the practice just before the speculative bubble of still requiring lenders to come up with 5%-10% of the down payment, and financing the rest with the second trust.
The other solution is an older one, and the subject of this topic. A lender may extend a first trust mortgage beyond the usual 80% of indebtedness. However, doing so causes him to assume more risk. As a result, he requires the lender to take out an insurance policy for the amount of the loan that exceeds 80% of the purchase price. Once the homeowner pays down the mortgage to the point where the 80% line is crossed, the insurance ends. This insurance is known as PMI, and the premiums are added as a cost of the mortgage.
PMI is not deductible, nor should it be. It's functionally no different than homeowners insurance, homeowners association fees, or utilities, for that matter--it's a cost of owning a home. It's bad enough tax policy that mortgage interest, points, and property taxes are deductible--never mind adding something else to the mix.
However, Congress did create one exception to this rule. In December of last year, Congress passed H.R. 6111 the "Tax Relief and Health Care Act of 2006." Section 419 of that bill creates a limited deduction for PMI premiums. The limitations are:
- The mortgage must be entered into in calendar year 2007. Prior year mortgages don't count.
- The mortgage must be to acquire a primary residence. Refinancings are out above and beyond the acquisition indebtedness amount, similar to the way the AMT treats equity loan interest.
- The deduction phases out between $100,000 and $110,000 of AGI ($50,000 to $60,000 of AGI if married filing separately).
- The deduction is only in place for 2007.
- Prepayment of PMI for future years is not tax-deductible.
If you can manage to shoehorn your way into this deduction, be my guest. Personally, it doesn't make a heck of a lot of sense to me.
If I'm looking to get a mortgage, and I want to get financing for the 20% down payment, I will try to get a second trust mortgage. At least that way, I can have some confidence going forward that my interest payments will be deductible. Betting on a Democratic Congress extending a tax cut is a dicey proposition at best.