Do we really need to give high wage earners a huge tax break as an encouragement to take on excessive debts? That’s what the home mortgage interest deduction really does. If the deduction were eliminated, home values in areas like Orange County populated by high wage earners would drop to establish a new equilibrium, but nobody would go without. In fact, the home mortgage interest deduction does little or nothing to increase home ownership rates because the low wage earners at the fringe of affordability don’t use the deduction anyway. Studies have show home ownership rates are just as high in countries like Canada that do not have the deduction. So why do we keep it? Apparently, there is a lot of political pressure even from those who don’t utilize the subsidy.
As a renter paying fair-market value for my property, I am getting subsidized by no one. I am the odd man out subsidizing everyone else. I subsidize loan owners through the home mortgage interest deduction. I subsidize low-income home owners through low-income housing tax credits. I subsidize other renters through the section 8 program. The government gives me nothing for renting at fair-market value; in fact, section 8 renters actually drive up the rental rates I would be paying by bidding up the prices of all rentals in the marketplace. My tax subsidies are actively working against me.
I believe we should eliminate the home mortgage interest deduction. It should be done slowly over time by gradually lowering the cap and raising the personal exemption. Lowering the cap will take away the benefit from high wage earners, and raising the personal exemption would make even fewer low wage earners itemize and take the deduction. It doesn’t seem likely any such change would happen in a vacuum. The only way the deduction is changed is in part of some grand compromise, but with gridlock in Washington, I am not holding my breath.
Why today’s discussion of the deduction may be purely political
CHICAGO (MarketWatch) — The housing market isn’t often a talking point for the presidential candidates as they focus on broader economic themes and job creation.
But there has been some discussion of the future of the mortgage-interest deduction.
Fear not, if you’re someone who benefits from the deduction: Politically, it remains nearly impossible to get rid of the perk.
“Now is not a great time to do something like this,” said Roberton Williams, senior fellow at the Tax Policy Center, a joint venture of the Urban Institute and the Brookings Institution, made up of experts in tax, budget and social policy. “Many homeowners rely on the cost of the deduction,” he said, “and if you undo that, there are enough people who are close enough to not being able to cover their mortgages that they’d be in trouble.”
The fact that so many loanowners exist on the margin is why any change to the HMID would be very gradual. Rising incomes would need to compensate for the lost write offs or many people will opt to sell their current homes. Those who are above water will sell, but those who are below water will strategically default or short sell contributing more to bank losses and ultimately taxpayer losses.
Plus, powerful groups including the National Association of Realtors and the National Association of Home Builders lobby heavily on behalf of the deduction. On its website, NAR calls the deduction “a remarkably effective tool that facilitates homeownership.”
So why does removal of the deduction even come up?
“Part of it is the fact that Romney has proposed half a tax plan. His tax plan says here is what we’re going to do with tax rates — we’re going to cut them a lot,” Williams said. “If you’re doing the boogeyman stuff, he’s coming after your mortgage-interest deduction. It’s hard to imagine he wouldn’t go after those because he needs so much revenue to make up for the tax rate.”
As you might suspect, Democrats are fine with having you think that Republican presidential candidate Mitt Romney would cut the mortgage interest deduction, Williams added.
That’s even though the Republicans inserted language in their platform about the deduction, saying they would preserve the mortgage-interest break in the event that Congress fails to accomplish wider tax reform.
Meanwhile, President Obama has made clear the deduction would be safe under his watch. “I refuse to ask middle-class families to give up their deductions for owning a home or raising their kids just to pay for another millionaire’s tax cut,” he said during his acceptance speech at the Democratic National Convention.
Obama is on the correct side of this issue politically, but as a policy, it’s still flawed.
Just because the deduction probably won’t go away soon doesn’t mean it shouldn’t be tweaked, according to some.
The deduction’s roots go back to 1913, when taxpayers were able to deduct interest paid on any loan, said Anthony Randazzo, director of economic research for the Reason Foundation, which describes itself as a think tank with the goal of advancing values of choice, individual freedom and limited government. “In 1986, Reagan tax reforms got rid of a lot of that, but interest on a mortgage was allowed to stay in the tax code.”
One of the main reasons this deduction was allowed to stay is because it created a strange imbalance between owner-occupants and landlords. A landlord can deduct the mortgage interest, but a homeowner could not. This gave landlords a potential advantage that could have adversely impacted the ownership rate, so the HMID was allowed. In the real world, landlords don’t generally compete with owner-occupants on desirable properties because landlords want positive cashflow, so any impact on the home ownership rate would be very small.
But now, to fully justify the mortgage-interest deduction, it would be worthwhile to explicitly define what it aims to do.
If the goal is to help people with lower incomes, the deduction doesn’t really get the job done, Randazzo said.
“For those people who do itemize, you have to be earning at minimum $35,000 to get more than maybe an $8 a month benefit on your mortgage,” Randazzo said. “Even up to $75,000 a year, you are getting a $179 annual average savings from the mortgage-interest deduction. That’s less than $15 a month benefit.”
People who benefit the most from the deduction are between the ages of 25 and 35, and have household incomes of more than $250,000, according to Reason research. Younger homeowners tend to benefit more than older ones because their mortgages are newer, and a larger percentage of their payments are going toward the loan’s interest.
It also benefits HELOC abusers and Ponzis who maximize their mortgages to live off the mortgage equity withdrawal. Another limitation I would put on the HMID is that it can only exceed the original loan balance if a verifiable property improvement is made, otherwise we are subsidizing people’s consumer spending with tax breaks.
If the goal of the deduction is to entice people to buy homes, it also isn’t the best policy, Williams said. Economists haven’t been able to show it raises the rate of homeownership, even though real-estate agents often tout it as a benefit.
Even so, “if the deduction disappears, [home] values will go down,” Williams said. “People who currently own houses will take a hit. They will not be worth as much as they are today, there’s no way around it.”
And that’s why is doesn’t happen.
The removal of the deduction would cause people to bid less money for the same home, since they wouldn’t be able to rely on the tax break, he added.
It likely would take more of a shift in attitudes about homeownership for the deduction to be eliminated, and that could be coming — especially if the proposed qualified residential mortgage proposal requires people to put 15% to 20% down to buy a home, Randazzo said.
Some would say it’s already starting to shift, given the recent growth in popularity of renting, he said. Yet for many, owning a home is still a large part of the American dream
Still, if the deduction goes away, it would likely be part of a much broader reform of the tax code, Randazzo said.
“The way [elimination of the deduction] is going to happen is part of a grand bargain,” Williams said. At that point, the deduction could be just “one of the things that falls by the wayside.”
Yes. That’s the only way it would happen.
The people who benefit from the home mortgage interest deduction want to see it preserved for selfish reasons. People like me who pay the subsidy want to see it eliminated, also for selfish reasons. So what do you think? Should we keep it or get rid of it?
They maxed out their deduction
The former owners of today’s featured REO were Ponzis. Not just did they gain advantage of all the mortgage equity withdrawal, they also got a massive home mortgage interest deduction — another reward of HELOC abuse that’s often overlooked.
- This property was purchased on 9/8/2000 for $385,000. The owners used a $308,000 first mortgage, a $38,500 second mortgage, and a $38,500 down payment.
- On 4/16/2001 the refinanced with a $308,000 first mortgage and a $38,500 stand-alone second.
- On 8/17/2001 they refinanced with a $332,000 first mortgage and a $14,500 stand-alone second.
- On 11/21/2001 they refinanced with a $348,000 first mortgage and a $34,000 HELOC.
- On 6/9/2003 they refinanced with a $340,000 first mortgage.
- On 3/2/2004 they refinanced with a $334,000 first mortgage.
- On 11/2/2005 they obtained a $500,000 HELOC.
- On 11/1/2006 they refinanced with a $775,200 first mortgage.
- On 12/1/2006 they obtained a $185,000 HELOC.
In just over five years, they withdrew $613,700 from this property.
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Proprietary OC Housing News home purchase analysis
$614,900 …….. Asking Price
$385,000 ………. Purchase Price
9/8/2000 ………. Purchase Date
$229,900 ………. Gross Gain (Loss)
($30,800) ………… Commissions and Costs at 8%
$199,100 ………. Net Gain (Loss)
59.7% ………. Gross Percent Change
51.7% ………. Net Percent Change
3.8% ………… Annual Appreciation
Cost of Home Ownership
$614,900 …….. Asking Price
$122,980 ………… 20% Down Conventional
3.53% …………. Mortgage Interest Rate
30 ……………… Number of Years
$491,920 …….. Mortgage
$112,406 ………. Income Requirement
$2,217 ………… Monthly Mortgage Payment
$533 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$154 ………… Homeowners Insurance at 0.3%
$0 ………… Private Mortgage Insurance
$0 ………… Homeowners Association Fees
$2,904 ………. Monthly Cash Outlays
($346) ………. Tax Savings
($770) ………. Equity Hidden in Payment
$139 ………….. Lost Income to Down Payment
$174 ………….. Maintenance and Replacement Reserves
$2,100 ………. Monthly Cost of Ownership
Cash Acquisition Demands
$7,649 ………… Furnishing and Move In at 1% + $1,500
$7,649 ………… Closing Costs at 1% + $1,500
$4,919 ………… Interest Points
$122,980 ………… Down Payment
$143,197 ………. Total Cash Costs
$32,100 ………. Emergency Cash Reserves
$175,297 ………. Total Savings Needed
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