Home buyers and refinancers who take out low-downpayment loans using any form of mortgage insurance -- FHA, VA guaranty or private coverage -- may get a surprise benefit next month: For the first time ever, they may get the right to deduct their monthly mortgage insurance payments just as they currently get to write off mortgage interest payments.

It's not a done deal yet, but Capitol Hill sources say the prospects are good that pending federal tax legislation will allow mortgage insurance tax deductions when it goes to the President's desk before the end of the year. The write-off provision is tucked away inside a massive $60 billion bill passed last week by the Senate 63-44. The House is expected to pass its own tax bill after the Thanksgiving recess, but without a mortgage insurance deduction sanction. Senate and mortgage industry sources say it is highly likely that a House-Senate on the two bills will approve the Senate's concept, in part because it has bipartisan support from more than half of the members of the House of Representatives, and in part because this year's Senate bill authorizes deductions only for new mortgage insurance policies written during calendar year 2007, thereby cutting revenue costs.

In two prior congressional sessions, the mortgage insurance deductibility issue failed to make it into law. This year, say sponsors of the legislation, the result should be different. Though the deduction authorization is limited to new loans made next year, the expectation is that, once incorporated into the tax code, the pro-homeownership, pro-consumer deduction provision will either be reauthorized on an annual basis or made permanent in future tax legislation.

The Senate-passed provision would essentially nullify a long-standing ban by the IRS against mortgage insurance deductions on federal income tax filings. It would permit full write-offs of FHA, VA and private mortgage insurance (PMI) premium payments for households with annual incomes up to $100,000. Households with incomes above that threshold would be limited to partial write-offs under a phase-out formula.

Deductibility of mortgage insurance is an issue with significant social as well as financial implications. That's because mortgage insurance premiums are paid for primarily by home buyers with modest incomes and insufficient savings to make a conventional downpayment. FHA mortgage insurance, which allows buyers to make minimal 3 percent downpayments, predominantly serves first-time and minority purchasers. Private mortgage insurance serves a similar group of modest-income consumers.

Proponents of deductibility argue that mortgage insurance premiums are the functional equivalent of mortgage interest payments, which are deductible for homeowners on up to $1.1 million in mortgage debt. Why not allow less-wealthy buyers to write off premiums that get tacked onto their monthly principal and interest payments solely because they couldn't make a 20 percent downpayment? Even the IRS acknowledges this: When a lender incorporates a borrower's mortgage insurance into the note rate -- bumping it up by a quarter of a percentage point or more -- the IRS permits the rolled-in premiums to be fully deducted, just like interest.

Published: November 28, 2005

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Kenneth R. Harney writes an award-winning, nationally-syndicated column on housing and real estate from Washington, D.C. He is also managing director of the National Real Estate Development Center, a professional education company. He is a past member of the Federal Reserve Board's Consumer Advisory Council, a committee that by federal statute reviews all Fed actions on home mortgage, consmer credit and banking industry regulation. He served as a member of the U.S. Department of Housing and Urban Development's Working Group on Computerized Loan Origination (CLO) systems, and is a member of the Editorial Board of the Fannie Mae Foundation's journal, Housing Policy Debate. He is the author of two books on mortgage finance and real estate.