A “New” Form Of Mortgage Insurance That Gives Tax Deductions To Everyone

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Private Mortgage Insurance (PMI) came back in vogue in 2007 for a number of reasons, the most widely-known of which was that PMI was suddenly tax-deductible.

But it came with a catch.  Only families earning less than $100,000 could take the full tax deduction.  For everyone else, PMI was same as it ever was.

Quietly, though, a less-well-known mortgage option called "Lender-Paid Mortgage Insurance" is emerging as a popular PMI alternative.

Lender-Paid MI is winning hearts for two major reasons:

1. Tax deductions are available for all income levels, not just under $100,000
2. Lender-Paid Mortgage Insurance is less expensive than a comparable Private Mortgage Insurance program in the near-term

LPMI is nothing new; it just wasn't as popular back when private mortgage insurance was still cheap and home values were leaping year-over-year.

But the lower monthly carrying cost doesn't mean that Lender-Paid MI is a better choice for every homeowners vis-à-vis Borrower-Paid MI.

In fact, even though it's more expensive, there are certain cases where Borrower-Paid MI is actually preferred to Lender-Paid MI.  This is because Borrower-Paid MI eventually "ends".

With Borrower-Paid MI, a homeowner makes separate payments each month to the mortgage insurer and is required to do this until his loan-to-value dips below 80% (or whatever LTV the lender requires to remove PMI).

When the loan-to-value gets to the 80% point -- either through principal paydown, home appreciation, or both -- the mortgage insurance payment are no longer required and are eliminated.

To the homeowner, this is a true "cash savings" each month because a former monthly expense is now, well, former.

By contrast, Lender-Paid MI lasts forever.  This is because LPMI is an interest rate adjustment made at the time of closing.  A 6.000% rate becomes 6.250%, for example.

In exchange for making larger payments, the lender agrees to "insure" the home loan themselves.

The positive part of LPMI being a part of the home loan note rate is that the IRS treats the additional mortgage interest paid from the higher rate as a tax-deductible expense; there is no technical difference between a mortgage with LPMI and one without it.

The negative part is that as the home's LTV falls to 80% or lower, the LPMI-fueled higher interest rate remains.  It doesn't fall off like BPMI.

The only way that a homeowner can rid himself of LPMI is to remortgage into a new home loan.

In the end, electing between Lender-Paid MI and Borrower-Paid MI is not as simple as just making a payment comparison -- it requires attention to short- and long-term financial goals.

LPMI tends to be fit short-term planning and BPMI tends to fit long-term planning but there are always exceptions.  This makes choosing between the two more difficult than just finding "the lowest payment".