Quietly and amidst very little fanfare at the end of last year President Bush signed a bill into law making mortgage insurance premiums 100% tax deductible. With one quick stroke of the pen, the President created a tremendous amount of tax parity for a great number of Americans.

There was a time, in the not so distant past, when buying a home required a down-payment of twenty-percent. This was a difficult amount of money to save for a great number of people who desired to share in that quintessential piece of the American dream, owning your own home. Over the years lending restrictions loosened and less up-front money was necessary to buy a home and homeownership became attainable for many more hardworking Americans. However, lenders still hedged their bets and required something known as Private Mortgage Insurance for those borrowers who could not come up with the necessary twenty-percent down-payment. Private Mortgage Insurance (PMI) is default insurance on mortgage loans, provided by third-party insurance companies. PMI allows borrowers to obtain a mortgage without having to provide a twenty-percent down-payment, by covering the lender for the added risk of a high loan-to-value (LTV) mortgage. The less money a borrower could put down the higher the Private Mortgage Insurance premium. The advantage to both the borrower and lender is obvious, but the catch is that the borrower pays for this coverage in their monthly house payment not the lender and unlike interest paid annually, the PMI premium had no tax benefit.

People caught on to this and began to discover ways to avoid paying PMI. The most common way is to finance a home using a 'combo loan' whereby a homeowner takes out multiple mortgages simultaneously. Usually an 80% first loan followed by second position loan which makes up all or a portion of the remaining 20% of the purchase price. In many cases the combined payments still equal a single mortgage payment with PMI. However, the combo loan allows borrowers to make more of their house payment tax deductible. So combo loans have become more and more common.

However, not all people either qualified for a combo loan or wanted to make multiple mortgage payments. Underwriting guidelines for second mortgages are typically more restrictive than first mortgages and often require much higher FICO scores (credit scores) than their first mortgage counterparts, thereby forcing some people into loans with PMI as a means of financing a home. And still other people like the simplicity of making one mortgage payment. In both cases, until this year, these people may have been at a tax disadvantage versus those people that have multiple loans. But that changed on January 1, 2007.

Beginning this year, taxpayers who purchase or refinance homes and have incomes at or below $100,000 and who itemize their deductions may deduct 100% of the mortgage insurance premium from their itemized taxes. The premium deduction is reduced by 10% for each $1,000 by which the tax payer's adjusted gross income exceeds $100,000. This allows single loans like FHA insured or Fannie Mae MyCommunity loans, both of which have comparatively low interest rates, much more attractive to a great many potential homebuyers.

Here is a real world example for comparison that illustrates how a single loan with PMI is better than a combo loan: Let's say we have two equal borrowers buying a $200,000 home and financing 100% of the purchase price. Our first borrower chooses a single 30-year loan of $200,000 at 6.50% with PMI making his monthly payment including the PMI equal $1,424.00. The second borrower does a first and second combo of $160,000 at 6.50% and $40,000 at 9.00% making his total monthly payment $1,417.00. On the surface the second borrower is saving $7.00 more on a month over month basis. But let's dig a little deeper into the specifics of each situation. Our first borrower has a principal and interest payment of $1,264.00 and the remaining $160.00 is the monthly PMI. In a 28% tax-bracket, the first borrower is able to deduct $347.00 per month from his/her overall tax bill, $302.00 for the mortgage and $45.00 for the PMI, making his effective mortgage payment $1,078. Our second borrower has two payments, $1,011 P&I on his first and $406.00 P&I on his second. Again, in a 28% tax-bracket the second borrower is able to deduct $324.00 from his tax bill, $241 for the first and $83.00 from the second, making his effective mortgage payment $1,093. In the end our borrower with PMI is making an effective mortgage payment that is $15.00 per month lower than the person who took out the combo loan.

The above example does not always work however. Factors such as combined loan-to-value (CLTV) and interest rate can significantly alter the calculations above. For those borrowers that are paying lower interest rates on their second mortgages or that have a CLTV of less than 90% a combo loan may make more sense. Additionally, the example is just that, an example and should not be taken as specific tax advice. I am a firm believer that everyone should use a tax professional when it comes to tax preparation and planning.

So is a one loan purchase or refinance the right move for you? It might be. I believe that it ultimately depends on your individual situation and should be discussed thoroughly with both your mortgage and tax professionals. But it is certainly worth spending the time to talk to the professionals to find out.

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