Mortgage News & Commentary - Watching The Fed

By
Steven Lord

Any Port in a Storm

The New PMI Deduction
January 18, 2007

The U.S. government just threw the housing market a life preserver – a small, entirely inadequate one, but a life preserver nonetheless. With the media focused on Saddam’s demise and year-end celebrations, it merited hardly a mention. But it significantly changes the real-estate playing field in 2007.

Most of the available data continues to suggest that the U.S. residential housing industry is undergoing one of the most painful corrections in a generation. Sales of existing home sales are running 10-15% below last year’s levels, while the inventory of unsold homes is well over seven months and a full 20% above last year’s levels. Lennar, a major U.S. homebuilder, slashed its fourth-quarter profit expectations by an amazing 45%, citing lower profit margins and the deterioration in the U.S. housing market. Significantly, Lennar’s announcement includes some $500 million in charges related to deposit refunds and costs for land it no longer intends to buy. Housing-related industries are shedding jobs left and right, and economists openly fret about the downstream effects of a housing market in free fall.

So it comes as little surprise to see the government try to soothe the pain in any way possible. Just before they went on break for the holidays, Congress passed an $40 billion omnibus tax bill that included, among other things, a provision to allow some homeowners to deduct the expenses of personal mortgage insurance (PMI) from their taxes.

This is significant. Buyers who put down less than 20% of a home’s purchase price are usually required to have PMI, something that has become more common as the price of a house has skyrocketed and homebuyers stretched their checkbooks to get into good areas. As usual, the devil is in the details; only loans made in 2007 will qualify (unless Congress extends the law next year, which is very likely), and there are income limits that basically restrict the full benefit of the tax deduction to homeowners making $100,000 per year or less. Those earning more can write off a portion of the PMI costs.

The impact of the new law on the housing market may be like throwing a cup of water on a forest fire. But there is no denying that the new law makes getting a mortgage easier, especially for first-time or low & middle-class homebuyers, and over one million people are expected to need PMI this year.

Even more importantly, the overall risk in the mortgage market may be lessened. Since many people didn’t want the added expense of PMI and many banks are more than willing to lend them additional money, so-called “piggyback” mortgages have become very common. In the case of a piggyback, the homebuyer takes a home-equity loan out on the house they are simultaneously buying to cover some of all of the down payment. This allowed the homebuyer to avoid paying for PMI while also being able to write off the interest on the piggyback loan. Extremely low interest rates on home equity loans and lines of credit encouraged buyers to use piggybacks instead of PMI for the past several years, significantly increasing their leverage to the housing market.

But there is little doubt that a person who has borrowed the cost of a down payment, no matter the tax benefits, is a greater risk than one who has not. The PMI deduction is a small but significant move to help make mortgages more affordable and level the playing field versus piggybacks. And with rates for home-equity loans climbing, the cost of a piggyback loan has been rising, so the tax bill couldn’t have come at a better time.

No one knows how long the housing slump will last. Some readings in November & December have edged up since October, spurring hopes that the worst was over, but I wouldn’t bet on it. And banks are going to cry foul over the PMI deduction, since it will take some of their easiest money – the piggyback loans – right out of their hands. Regardless, the PMI deduction is long overdue and will make it that much easier for people to buy a home. And considering what the market has gone through since the summer, now is probably a great time to be buying a house.

Other Articles by Steven Lord:
Call To Arms - 06/15/2006
Refi Boom Over? - 09/14/2006
Watching The Fed - 12/04/2006
Other Peoples Money -11/14/2006