Mortgage lenders often require mortgage insurance on loans with less than 20 percent equity. Mortgage insurance covers both purchase and refinance transactions. Mortgage insurance protects the lender from losses in the even the mortgage forecloses. Lenders know foreclosed homes often sell for less than full value. This causes mortgage companies to lose money when they lend more than 80 percent of the home’s value. Mortgage insurance protects the lender’s bottom line in exchange for premiums included with the mortgage’s monthly payment.
Mortgage insurance is deductable for mortgages closed on or after January 1, 2007 through December 31, 2010. Starting on January 1, 2011, mortgage insurance will no longer be deductable. The government created the deduction to help homeowners who chose mortgage insurance instead of a second mortgage. Often to avoid mortgage insurance, homeowners would obtain a second mortgage for the difference between their 80 percent loan to value first-mortgage and their down payment. One key advantage the second mortgage provides is tax deductibility of the interest.
Not everyone can deduct mortgage insurance on his or her tax returns. The law provides this deduction only for homeowners with a household income of $100,000 or less. Since this is based on household income, you must include your spouse’s income, even if the spouse is not on the mortgage or the mortgage insurance. Refinancing your loan to remove your spouse just so you can qualify for the deduction likely will not work.
The mortgage insurance tax deduction follows the other rules that govern mortgage interest as well. You must itemize, and not take the standard deduction available on the tax return. This also requires you to complete a full 1040 and schedule A and not just file a short form or 1040-EZ tax return.
Choosing Mortgage Insurance
Do not choose mortgage insurance just because it is deductable. There is no guarantee Congress will renew the deduction. If your lender requires you to have mortgage insurance, ask if a second mortgage is possible. Depending on the mortgage type, and your financial situation, a second mortgage may be a better option. Mortgage insurance also is available with several different payment options. The most popular is monthly paid mortgage insurance. The payment is included in your monthly mortgage payment, and the lender pays the mortgage insurance company for you. Many mortgage companies also offer single payment mortgage insurance. This plan requires one lump sum payment when the loan closes, based on a percentage of your loan amount. You can make this one-time payment, and deduct the entire amount from your taxes since there isn’t a maximum amount of mortgage insurance that can be deducted each year.