Almost every average homeowner in the US has a mortgage looming over his property.
The mortgage industry is big business in America for sure. Owning a home is a common – and quite reasonable – dream for many.
The most feasible way to go about acquiring a home is by opting for a mortgage loan.
These days it is nearly impossible to buy your own home without a mortgage, even if it is a second-hand home.
Mortgage loans are indeed a blessing since they have really paved the way for more and more people to own homes today. It would be wonderful if everyone could afford to buy a home with funds readily available out of their pockets. However this is not a very practical approach.
Yes, mortgage loans are debt and one must be wary of incurring too much debt. Nevertheless, mortgage loans can be classified as good debt. If managed properly, mortgage loans can undoubtedly be a boon to most people.
There are many different types of home loans available for the potential home owner today. You could choose from conventional loans, FHA loans or perhaps even a jumbo loan. This brings us to the next question.
A FHA loan is one which is supported by the Federal Housing Authority. These loans are harder to obtain than the conventional ones. They are only available with specific lenders, for specific properties and for well qualified individuals with great credit scores. As you can see not everyone can get an FHA loan
However the one big advantage of the FHA loan is that you can obtain it with a very less down payment amount. Usually, the down payment amount for FHA loans range between 3.5 – 4 % of the property value.
In contrast, down payments for conventional loans can be huge. Normally, it ranges from 10 – 30 % of the property value. FHA loans are somewhat rigid in terms of duration of loan and repayment plans.
On the other hand, conventional loans can be more flexible. Plus there are limits to the amount of money that can be lent as a FHA loan whereas no such limits are present for conventional loans. It is typically upto the discretion of the lender involved. Some people prefer to go the conventional way while others prefer to opt for FHA loans.
|Risk to lender||High||Low|
|Qualification process||Simple & Straightforward||Strict & elaborate|
Before we talk about mortgage insurance, let’s first be clear about what is insurance. Insurance, is a legally binding agreement between the insurer and the insured. It is the promise to compensate for any potential losses that the insured might incur. Insurance is a great way to manage your risks.
Insurances can be taken out for lives, property, cars and businesses. In exchange for this guarantee the insured pays a periodic fee called the premium for a stated period of time. Now that we understand what is insurance, let’s move onto mortgage insurance.
Yet another difference creeps in between FHA loans and conventional loans, in the form of mortgage insurance. For FHA loans, this mortgage insurance comes in the form of Mortgage Insurance Premium (MIP).
What is Mortgage Insurance Premium? This is a fee that you pay in order to protect the lender from a loss in case you default on your loan and fail to repay it.
For conventional loans this mortgage insurance takes the form of Private Mortgage Insurance (PMI). Since conventional loans do not have the backing of the FHA, the lender is bestowed with a higher risk as compared to the FHA loans.
As a natural result, private insurance mortgage charges tend to be higher. This is especially true if you are unable to put down at least 20 % as a down payment.
The down payment amount is inversely proportional to the risk to the lender, while the risk to the lender is directly proportional to the mortgage insurance rates. In other words, the lower the down payment, the higher the risk to the lender and hence the higher the mortgage insurance rates.
Who doesn’t like to save money, right? Your question is absolutely valid. But you might be disappointed with the answer if you are opting for a FHA loan. Experts agree that it is almost impossible to avoid paying a mortgage insurance premium for FHA loans.
But coming to conventional loans, there are ways to avoid paying private mortgage insurance. The most obvious route is to cough up more money for the down payment amount. As this reduces the risk to the lender, the mortgage insurance also comes down automatically.
For example, let’s assume that your home is valued at 150,000 USD. Now, if you can come up with at least 30,000 USD as a down payment, then you can escape the mortgage insurance fee.
Another possible way to avoid a mortgage insurance is to try getting a piggyback mortgage. This means that instead of taking out one huge mortgage loan, you take out two loans together with an 80:10:10 ratio.
Therefore, going with the same example, if the value of your new house is 150,000 USD, then your first loan value would be for 120,000 USD. The second mortgage would be for 15,000 USD, and your down payment amount would also be 15,000 USD. How does this help?
Piggybacking mortgages can reduce the Loan to Value (LTV) ratio of your mortgage. Loan to Value ratio is the ratio of the mortgage amount to the value of the property for which the loan is required. Loan to Value ratios are directly proportional to the risk of the loan. Hence a lower LTV will reduce the risk, thereby eliminating mortgage insurance.
At times, financial institutions might also offer to waive off the mortgage insurance, if you avail of their special promotions in a particular area or community.
Alternatively, another option is to avoid paying the mortgage insurance but to instead increase the interest rate for the loan. This can be termed as lender-paid mortgage insurance. Essentially the cost of the mortgage insurance is added onto the interest of the loan, which you pay up over the course of repaying the loan.
Last but not the least, you can also consider going for refinancing in order to eliminate paying private mortgage insurance. This is especially valid in cases where the value of your property has appreciated considerably since the time you took out the loan.
Say, you have been paying back the loan regularly and the equity in your home has increased well enough. Then it would mean that the Loan to Value ratio has lessened in your favour. So as explained earlier, you could qualify to avoid paying the private mortgage insurance when you refinance.
You could also improve the market value of the home by building an extension or by improving its facilities.
Be aware that there tends to be a cautionary period of 2 years before you can refinance a mortgage loan to eliminate private mortgage insurance. So if it has been less than 2 years since you’ve taken out the mortgage loan, then you might have to wait a bit.
Good news! Yes, mortgage insurance premiums are tax deductible, provided you fulfill certain specific criteria. Firstly, mortgage insurance premiums are deductible for loans that have been taken on or after January 1, 2007.
Also, the loan must have been used solely to purchase, build or remodel a house which is either your first or your second home. This is called as a home acquisition debt.
Next, we come to your Adjusted Gross Income, AGI in short. The income limits that have been set for this year, 2016, happens to be 109,000 USD for a single person filing a tax return. For a married person filing a separate tax return it is 54,500 USD.
Additionally, the phasing out income limits are set to 100,000USD for single people as well as married people filing a joint tax return. It is 50,000 USD for married people filing a separate return. What does this mean?
Let’s elaborate. For every 1000 USD of income that crosses the threshold value of 100,000 USD, 10 % of the premium amount is subtracted. Once your income levels cross 109,000 USD, you no longer become applicable for a tax deduction on your mortgage insurance premium.
Finally, you can apply for a tax deduction on your mortgage insurance premium only if it is an itemized tax deduction.
Tax deductions can fall under two broad categories – standard and itemized. Standard deductions are fixed according to your filing status. However, itemized deductions depend on your actual expenditures in that financial year.
Opting for standard deductions can be easier and makes for a quicker filing process. But if you feel that by opting for itemized deductions you will be able to save more money, then you should choose that path.
The most essential thing for filing itemized deductions is documentation. You will need to keep track of and save proof of all your expenses. Whether it is bank statements, acknowledgement receipts, bills, tax statements, whatever be it – you will need to submit as proof of expenses.
So if you are bad at documentation, then you might have no other choice than to go for the standard deductions.Why take the pain to go for itemized deductions you might wonder.
The answer is that at times you might end up getting more money back by choosing itemized deductions. The rule of thumb is that if the sum of your standard deductions is lesser than the sum of your itemized deductions, then it would be wise to go for itemized deductions.
This is a choice you can make every year – so if this year you decide to go for a standard deduction, next year you are allowed to either continue doing the same or to change your mind and go for itemized deductions instead.
By now, your head might possibly be swimming with jargons so let’s break it down in simpler terms with the help of an example. For instance, if your itemized deductions come to 5000 USD and your standard deductions come to 4700 USD, then obviously it would be better to go for the itemized deductions. This approach would reduce your taxable income by 5000 USD instead of only 4500 USD if you had gone for standard deductions.
One hitch about itemized and standard deductions is that if you are married then you and your spouse must file for the same type of deductions. You cannot choose an itemized deduction while your spouse opts for the other.
Expenses that can be classified as itemized deductions include but are not limited to medical expenses, charitable gifts and of course, mortgage insurance premiums.
Rules and regulations are revised and can change with every fiscal year. For the moment though, no limit has been set for the amount of money that you can claim as part of your tax deduction for mortgage insurance. You can get the document called Form 1098 from your lender.
If you ae thinking about taking out a mortgage loan, then do consider the above mentioned points before choosing one. Mortgage insurance premiums can add up to the total cost of the loan. Hence you will need to shop around, talk to potential lenders and compare costs before you sign up for a mortgage loan. It does involve a lot of ground work but it is a huge financial commitment and it definitely pays to do your research.