Many loan originators take the viewpoint that knowledge of the federal mortgage and housing tax laws is not necessary to successfully originate loans. I completely disagree. In fact, there are specific opportunities for you to generate more business by understanding various mortgage and housing tax concepts.
After all, the mortgage is inherently a financial transaction. While mortgage originators should not act as tax advisors, they should structure loans that are suitable for the borrower by understanding the tax consequences of various mortgage and housing strategies. At the very least, borrowers should not be placed in a worse tax or financial situation after dealing with an originator than they were prior to dealing with the originator. This is consistent with the goal of long-term, sustainable homeownership, is it not?
Consider these two examples where a working knowledge of federal mortgage and housing tax laws would be necessary for you to avoid committing loan origination “malpractice:”
Example #1: Financing the purchase of a second home
►The consumer currently owns a primary home worth $500,000 with a $100,000 mortgage.
►The consumer wants to purchase a second home for $200,000.
►Many, if not most, loan originators would structure the transaction in a way that involves pulling equity out of the borrower’s primary home for use as either a large downpayment or to purchase the second home for cash ($100,000-$200,000 of cash out).
In this example, there would be three main problems if a borrower pulls $200,000 of equity out of their primary home and refinances the mortgage to say, $300,000:
►The borrower would not be able to deduct the interest on any portion of the $200,000 of cash-out as acquisition indebtedness.
►If the borrower is not one of the six million-plus Americans subject to the Alternative Minimum Tax (AMT), they would only be able to deduct the interest on up to $100,000 of the cash-out as home equity indebtedness, and would not be able to deduct the interest on the remaining $100,000 of cash-out proceeds.
►If the borrower is one of the six-plus million Americans subject to the AMT, they would not be able to deduct the interest on any of the $200,000 of the cash-out.
Assume the mortgage carries a six percent interest rate, and the borrower is in a 25 percent federal income tax bracket. The inability to deduct the mortgage interest would cost the borrower $3,000 per year or $250 per month. Put differently, this would be equivalent to putting the borrower in a “high-cost loan”—defined by the Federal Reserve Board as 1.5 percent higher than the Freddie Mac average rates on first lien mortgages. Putting the borrower in a high-cost loan when lower cost alternatives are readily available is traditionally defined as predatory lending.
Don’t pull equity out of the primary home, and instead, place the mortgage on the second home that is being purchased. In that case, 100 percent of the mortgage interest would be deductible to the borrower as acquisition indebtedness. In this example, the borrower would save $3,000 per year or $250 per month.
Loan originators who are familiar with the acquisition and home equity indebtedness rules can avoid committing “malpractice” and predatory lending as outlined above. This is a prime example of why it is important for originators to understand certain federal mortgage tax laws. Knowledge of the acquisition indebtedness rules is also helpful in these situations:
►Determining whether the mortgage on a borrower’s primary residence is recourse or non-recourse in states that have anti-deficiency statutes, such as California and Arizona.
►Determining whether a short sale or loan balance reduction through refinance or modification would be taxable by the IRS as income to the borrower.
►Determining whether private mortgage insurance (PMI), Federal Housing Administration’s mortgage insurance premium (FHA MIP) or the Department of Veterans Affairs (VA) funding fee is tax deductible to the borrower.
While I am not suggesting that you give tax or legal advice, I am suggesting that a working knowledge of acquisition indebtedness and other tax rules can help you avoid placing borrowers in loans that are not suitable or otherwise defined as predatory lending.
Example #2: Downpayment funds for a first-time homebuyer
►A husband and wife are gifting $25,000 to their first-time homebuyer daughter for use as a downpayment on her new home.
►A daughter can qualify for a better rate on her mortgage if one or more of her parents co-sign on her mortgage.
►The daughter is willing to purchase a home after the expiration of the $8,000 first-time homebuyer credit because she doesn’t think she will be able to qualify for it if one or both of her parents co-sign.
►A husband and wife are also in the process of purchasing their own home. They are willing to purchase after the expiration of the $6,500 long-time residence homebuyer tax credit because they think they won’t be able to qualify for it because they are co-signing for their daughter’s mortgage.
►Parents are unsure of where to get the money for the $25,000 in gift funds because they don’t want to liquidate their own cash reserves due to their own homebuying situation.
Many, if not most, loan originators are unfamiliar with gift tax and homebuyer tax credit rules and are likely to lead the borrowers down a path of misinformation or making mistakes in structuring either one or both of the transactions in this example.
By simply giving the borrower information relating to the gift tax and homebuyer tax credit, the loan originator can literally save the borrowers more than $20,000.
►The daughter can qualify for the $8,000 first-time homebuyer tax credit even if there are co-signors.
►The parents can qualify for the $6,500 long-time resident homebuyer tax credit on the purchase of their home even if they co-sign for their daughter on the purchase of her home.
►The parents can save $5,400 in gift taxes by writing two separate checks for the $25,000 in gift funds to their daughter.
►The parents can preserve their cash reserves by pulling funds out of their IRA without penalties to help their daughter buy her first home (tax rules allow you to pull $10,000 per account holder out of an IRA, prior to age 59-and-a-half, without penalty, to buy your first home or help an immediate family member purchase their first home).
Again, I am not suggesting that you give tax or legal advice. I am simply suggesting that you help borrowers avoid loan situations that are more costly or otherwise not suitable for their situation by having a working knowledge of the gift and homebuyer tax credit rules.
By understanding the federal mortgage and housing tax rules, you could share generic information with borrowers that is helpful to their situation. After all, in the first example above, why would originating a loan that costs the borrower an extra $250 per month not be considered predatory lending, while other origination practices that have exactly the same high cost to the borrower would be considered predatory?
My personal opinion is that loan originators have a moral and ethical obligation to spot these issues, share this information with their borrowers, and then refer the borrowers to a tax and/or legal advisor for specific advice pertaining to their situation. As a consumer, wouldn’t you much rather deal with an originator who is properly educated in this area than one who is not? As a CPA, financial advisor or Realtor, wouldn’t you feel more comfortable referring your clients to a loan originator who is familiar with these rules as opposed to one who is not? Certified Mortgage Planning Specialist (CMPS) certification equips you with unique knowledge about these and other federal tax rules that can help you stand-out from your competition, avoid predatory lending situations, and generate more business from clients, prospects and referral partners.
Gibran Nicholas is the founder and chairman of the CMPS Institute, which administers the Certified Mortgage Planning Specialist (CMPS) designation. The CMPS Institute has enrolled more than 5,500 members since its founding in 2005. Gibran is also the chairman of Published Daily, a customizable online magazine, newsletter and marketing service that helps professionals transform their clients and prospects into a referral-generating sales force.