New tax law tweaks home-buying math

NEW YORK (CNNMoney.com) -- A $40 billion tax bill signed into law Wednesday by President Bush extends several popular tax breaks and introduces a new one - tax-deductibility of private mortgage insurance (PMI).

Only homeowners with adjusted gross income less than $110,000 and who itemize their deductions will be eligible to reap the benefit.

But for those buyers, it will change the math of buying a house with a low or no down payment.

"I love it," says mortgage broker Bob Moulton of Americana Mortgage Group, "Even though it's limited in who can qualify, it helps people get into a home."

Most lenders require buyers putting less than 20 percent down to purchase PMI because borrowers are more likely to walk away from a mortgage when they have less of their own money invested in the property. Lenders use PMI to protect themselves against that risk.

The alternative to PMI is an equity loan "piggybacked" on top of the first mortgage. According to Moulton, extremely low interest rates on home equity loans (HELs) and lines of credit (HELOCs) encouraged buyers to use piggybacks instead of PMI the past several years.

In addition, equity loan interest is tax deductible. With that advantage and the low rates, piggybacks became far cheaper than PMI.

That situation has reversed because equity loans are based on the prime rate, which has climbed from about 4 percent to 8.25 percent.

Today, according to Moulton, on a $225,000 home, the piggybacked portion of the loan would cost about $4,000 a year while the PMI payment would come to about $3,000 - or less - depending on the borrower's credit score.

The tax deduction on the equity loan would be about $1,600 for a borrower near the upper income limit. With the new law, the PMI tax break would be about $1,200.

That means choosing PMI would cost $1,800 compared with $2,400 for the piggyback loan, an $800 savings.

"It's tough to justify going for a piggyback now," says Moulton.

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