The same new federal law that offers relief from mortgage debt forgiveness taxes, also extends tax benefits for many more homeowners who pay mortgage insurance.
Effective January 1, 2008, according to the "Mortgage Forgiveness Debt Relief Act of 2007 ," for those eligible, no taxes will be owed on any mortgage debt forgiven or written off as part of a short sale, foreclosure, renegotiation, bankruptcy or other such action on a principal residence.
Before the law was passed, such forgiven debt was typically taxed as income.
The relief act came on the heels of a housing and mortgage crisis after risky subprime and non-traditional home loans blew up in the faces of many homeowners and spilled foreclosure ash over the economy.
The relief act's debt forgiveness portion protects up to $2 million of indebtedness from taxation if the debt is secured by a principal residence and if that debt stems from the acquisition, construction or substantial improvement of the principal residence. This special relief is available retroactively for eligible debt discharges from Jan. 1, 2007, through Dec. 31, 2009, for those who qualify.
While the debt relief portion of the relief act is making all the headlines, another provision that extends a mortgage-related tax deduction is likely to benefit more homeowners.
The relief act also extends federal tax relief for homeowners with low down payment mortgages who pay mortgage insurance. The extension allows eligible homeowners to continue to deduct the cost of their government or private mortgage insurance premiums for three more years. The original one-year provision was set to expire Dec. 31, 2007.
A tax deduction, by the way, reduces taxable income, leaving less income to tax.
Now, qualified borrowers will be able to take the deduction if their insured mortgage originates between 2007 and 2010, instead of just for the year of 2007. Qualified borrowers are families with an adjusted gross income of $100,000 or less. Families with incomes up to $109,000 are eligible for a partial deduction.
Lenders levy mortgage insurance to protect themselves from risk when a borrower's down payment is less than 20 percent of the purchase price and other loans are not used to make up the difference.
The homeowner pays the premium (averaging $50 to $100 a month, for the national median priced home), but the insurance protects the lender from the risk of financing more than 80 percent of the cost of a home. Studies show borrowers with smaller starter equity stakes have more problems than those who have larger equity stakes.
To protect mortgage insurance consumers, the federal "Homeowners Protection Act of 1997" gave homeowners disclosure rights and broader insurance cancellation rights they can use once they reach certain equity levels.
The mortgage insurance provision of the new relief act may be the federal law's best provision, in terms of the number of homeowners who will benefit.
Economy.com estimates that forgiven debt tax relief could apply to 750,000 homeowners, but would likely end up benefiting only 250,000.
During the first year of the mortgage insurance tax deduction, the Mortgage Insurance Companies of America (MICA) estimated 2 million families would benefit from the deduction, resulting in an average tax savings between $300 and $350.
"Continuing this tax deduction will help low- and moderate- income consumers, particularly first-time home buyers who are unable to put down 20 percent," said Kevin Schneider, MICA president.
Even with home prices declining in many areas, many families find it difficult to accumulate a 20 percent down payment. The need for insured mortgages with low down payments continues to grow and the mortgage insurance method for meeting the needs of certain borrowers, has a better track record than subprime loans.
Suzanne Hutchinson, MICA's executive vice president says, "As risky, exotic loans are no longer considered viable housing finance options, more secure loans with private mortgage insurance remain readily available for qualified borrowers."
