Up until former President Bush signed into law the Tax Relief and Health Care Act of 2006, mortgage insurance premiums were not tax-deductible. Borrowers can now deduct those payments. On the surface, this sounds like good news for first-time homebuyers. But is it?
One of the driving forces behind taking out piggyback loans, also called combo loans, was the tax deduction available for paying all that interest versus paying a mortgage insurance premium that was not tax-deductible on a single loan. The second benefit is that the total payments on a combo loan are often much lower than payment with a private mortgage insurance.
How Combo Loans Work
Combo or piggyback loans are financing that combines a first mortgage with a second mortgage (with or without a down payment). The reasons these types of loans are appealing are because many homebuyers may not have 20% of the purchase price in cash or do not want to put down 20% to buy a home — and combo loans sidestep the requirement to pay PMI. Common types of combo loans are:
This scenario involves putting down 5% and financing the first mortgage of 80% of the purchase price, coupled with a second mortgage comprising 15% of the purchase price.
This scenario involves putting down 10% and financing the first mortgage of 80% of the purchase price, coupled with a second mortgage comprising 10% of the purchase price.
This scenario involves putting down zero and financing the first mortgage of 80% of the purchase price, coupled with a second mortgage comprising 20% of the purchase price.
The interest rates on a second mortgage are higher than those on a first mortgage, but sometimes the total payments are less than those financed on the first mortgage with private mortgage insurance. Moreover, since combo loans reached a peak in 2005, many borrowers are considering other options because of short-term interest rate fluctuations.
Comparing PMI and Combo Loans
Let's compare two borrowers with identical FICO scores of 680. Here is how the numbers work:
Say the Klingon family buys a $500,000 home using 80/20 financing. The first mortgage would be at 6.25% and payable at $2,462.87 per month for principal and interest. The second mortgage would be at 8.5% and payable at $768.91 per month, principal and interest.
Total payments for a combo loan: $3,237.78
100% With PMI
But the Romulan family buys a $500,000 home using 100% financing with PMI insurance. The first mortgage would also be at 6.25% but payable at $3,079, and PMI insurance adds another $400 to that payment.
Total payments for the first mortgage with PMI is $3,479.
The Romulan family needs to wait two years and obtain an appraisal to show 20% equity to get rid of the insurance. But say the Romulans do and the payment drops to $3,079 without PMI. The Romulans would not pay less than the Klingons until month 63 of the loan.
Features of Income Tax Provision for MMI / PMI
Mortgage Insurance premiums (MMI) are paid on FHA and Rural Housing Loans, and some conventional loans require private mortgage insurance (PMI), both of which are deductible subject to certain provisions:
- The Tax Relief and Health Care Act provision for PMI tax deductions applied to fund after Dec. 31, 2006. This dating meant homeowners can deduct mortgage insurance on loans taken out in 2007. The even better news is the fact that the deduction has been renewed multiple times; most recently, under the Consolidated Appropriations Act of 2021, the tax deduction has been extended through 2025.
- Available to persons filing joint or single returns with less than $100,000 of adjusted gross income (AGI), or $50,000 AGI for married persons filing separately.
- Families earning above $109,000 AGI ($54,500 if married, filing separately) cannot take a deduction. But for those who earn between $100,000 and $109,000 AGI ($50,000 if married, filing separately), the deduction phases out.