If you’re looking for a new house, you have probably heard the terms PMI mortgage insurance and homeowner tax deductions, among a plethora of other terminology you don’t normally come across unless you are ready to buy a home. So what exactly does it all mean and why should you care? Well, the more educated you are when it comes to the home buying process the more likely you are to make better financial decisions based on your particular situation and the less likely you are to make any devastating errors. Real estate is extremely complex and not having at least the basic knowledge of the process could ultimately end up with you making a very costly mistake. Therefore, we are going to explain to you what the term PMI means and why you should care. Then we are going to explain the various tax deductions homeowners are eligible for and how these deductions can help save you thousands of dollars every year.
What Is PMI?
PMI stands for private mortgage insurance, which is sometimes mistakenly called PMI mortgage insurance. Since the term PMI is the abbreviation for private mortgage insurance, when people say PMI mortgage insurance, it’s like repeating the same thing. Therefore, if you want to talk intelligently when it comes to real estate, just refer to the private mortgage insurance as PMI.
The purpose of PMI is to reimburse the lender if you happen to default on your mortgage. What you pay for your PMI will depend on how much of a down payment you have on your loan and your credit score, but it’s usually somewhere between 0.3 percent and 1.5 percent of your original loan and it’s paid monthly every year until your loan reaches a certain point, which is what we will be discussing next.
When Can I Drop My PMI?
You can drop the PMI you pay on your mortgage once the outstanding loan balance falls below 78 percent of the home’s original value. When you have reached a loan balance of 80 percent, which means you have 20 percent equity in your home, you should contact the lender and ask if they will allow you to discontinue your mortgage insurance payments. Just realize that it will probably take you several years to get to the point where you no longer have to pay PMI.
There is one exception to the 80 percent rule for no longer having to pay PMI premiums, and that is with a recent change to how an FHA loan works. An FHA mortgage now requires that PMI be paid for the life of the loan and the only way to have that requirement canceled is to refinance the loan. According to the FHA’s new policy, you will have to make two PMI payments on all FHA loans. The first one is the upfront payment which is 1.75% of the mortgage amount. The second PMI requirement is that you will have to pay the annual PMI premium, as well, which can be paid in monthly installments and is based on the length of your loan, the amount you borrowed and the original loan-to-value-ratio of the home.
How Can I Avoid Paying PMI?
You should avoid paying PMI whenever possible. And for those who are qualified, this can be easily done by using a piggy-back mortgage. What is a piggy-back mortgage you ask? Well, a piggy-back mortgage, also known as a second mortgage, is a loan that’s taken out by a borrower at the same time as he takes out the first mortgage. These types of loans are typically used to lower the loan-to-value ratio (LTV) of a home, which will help a borrower qualify more easily and to eliminate the need for paying PMI. Not having to pay PMI premiums could ultimately save a borrower thousands of dollars on his mortgage. However, you will need to keep in mind that a second mortgage is usually charged a higher interest rate than your first mortgage. Therefore, you should make sure you are able to pay it off as quickly as possible. If you can’t, then you might be better off paying the PMI premiums, because if you can’t pay off your piggy-back loan quickly, it would probably be more cost effective to just go ahead and pay the PMI and drop it once you have reached 20 percent equity in your home. You also need to be careful with piggy-back loans because they can be a bit tricky. Quite often the terms of second mortgage include adjustable rates and they might also have a balloon provision included with them as well.
The only other way to avoid paying a PMI monthly premium is to put more than a 20 percent down payment on that home. Putting more than 20 percent down on a home is by far the best way to go because it will help with your loan being approved, you will generally get a better interest rate and you will (in most cases) avoid having to pay a monthly PMI premium.
Is My PMI Tax Deductible?
Whether or not your PMI is tax deductible will vary from year to year. Congress decides each year whether or not they will include PMI in their list of items that are or are not tax deductible for any given year.
What Kinds of Tax Deductions Are Available To Homeowners?
The great thing about becoming a homeowner is the long list of tax deductions you will receive. Some of the current tax deductible items include your property taxes, the mortgage interest, mortgage points, PMI (this can vary from year to year), capital home improvements (not repairs) and equity loan interest. Additionally, if you run a business out of your home, you will also receive a home office deduction. And in some cases, you can also deduct your moving expenses, as well.
*Please note: We are not tax professionals and the information provided herein is for informational purposes only. Please contact a tax professional for advice and recommendations for your particular tax situation.
2 Point Highlight
1. If you’re looking for a new house, you have probably heard the terms PMI mortgage insurance and homeowner tax deductions, among a plethora of other terminology you don’t normally come across unless you are ready to buy a home.
2. The more educated you are when it comes to the home buying process the more likely you are to make better financial decisions based on your particular situation and the less likely you are to make any devastating mistakes.
