Mortgage Interest Tax Deduction Go Bye-Bye?

A while back, I wrote on Inman (subscription required) that the single greatest asset of realtors was political power, and got mixed comments about that position.  Well, the time to find out is upon us:

The popular tax break for mortgage interest, once considered untouchable, is falling under the scrutiny of policymakers and economic experts seeking ways to close huge deficits.

Although Congress last year rejected the White House’s proposed cut to the amount wealthier taxpayers can deduct for home mortgage interest payments, the administration included it again in its 2010 budget — saying it could save $208 billion over the next decade.

When NAR lauched HouseLogic.com last year, one of the examples it used to talk about how important HouseLogic.com would be was defending the home mortgage interest deduction.  With the Obama Administration putting the elimination of the mortgage interest deduction back on the agenda for 2010, it’s time to find out just how powerful NAR is, and whether NAR does in fact add value to the Realtor or not.

Plus, given that the “recovery” of 2009 and spring of 2010 (I have my doubts on how much of the recent market is a recovery vs. simply pulling deals forward in time, but nevertheless…) was widely seen as having been fueled by a $8,000 first time homebuyer tax credit, the elimination of the mortgage interest should have interesting — if devastating — consequences for the market.

Is the Mortgage Interest Deduction That Big A Deal?

There are those, such as the Urban Institute, who think that the mortgage interest deduction doesn’t actually mean very much for homeownership:

The MID [Mortgage Interest Deduction] disproportionately benefits taxpayers in the top fifth of the income distribution (Toder, Harris, and Lim 2009). Those who do not itemize deductions on their tax returns receive no benefit and the subsidy rate is larger for individuals in higher marginal tax rate brackets. Because most who benefit would own homes without the deduction, it mostly provides an incentive to live in more expensive homes, not to own instead of rent. Other countries without an MID have similar homeownership rates.

Toder, et. al., might very well have a point… especially from a policy standpoint.  But that “mostly provides an incentive to live in more expensive homes” piece is going to affect brokers and agents whose incomes are directly tied not only to transactions but also to home prices.

The recent experience of the home buyer tax credit also suggests that eliminating the MID would have negative consequences.  If $8,000 was enough to get a bunch of buyers off of the sidelines and into homeownership, losing the MID may be enough to get a bunch of homeowners to sell, and even more people to wait on purchasing.

Just to put some numbers on this, based on this worksheet, a buyer who takes on a $240K mortgage in the 25% federal income tax bracket receives tax savings of more than $23,000 over the first seven years of homeownership (when the amortization is such that interest is the bulk of the mortgage payment).  That’s just over the first seven years.

Consequences to the Housing Market?

At this point, I think anyone who claims to know what the elimination of the MID would do the housing market is probably (a) smoking something, or (b) selling something.  At the same time, even if one doesn’t know for sure, it’s hard to imagine that getting rid of the MID would be a net positive for housing.

Even assuming that the Urban Institute and other critics of the MID are correct, buyers would then move down the price chain since the incentive to live in more expensive homes will be eliminated.  Housing prices may not collapse, but they’re certainly not going to go up.

Plus, maybe my wife and I are unique and different, but when we were first-time homebuyers, we definitely had conversations about the fact that the mortgage interest would be tax-deductible in our financial calculus about whether we should buy or continue to rent.  Without the MID, we may have held off our purchase for a few years longer and simply stayed out of the market.

Just the rumor of the MID going away is likely to influence the market:

ANOTHER UPDATE: A reader emails: “Speaking for myself, just the rumour of ending the mortgage deduction has caused me today to call off my house search. Not just because of the loss of the deduction to me personally, but because it’s easy to imagine this crashing prices, which is all you need to, in fact, crash prices.”

And finally, given the enormous shadow inventory of not-yet-released foreclosures and the extend-and-pretend games that banks are forced to play, it’s hard to imagine a scenario where the glut of inventory can be worked through faster by removing the mortgage interest deduction from play.

Nonetheless, who knows what the impact would actually be?

One thing I can surmise for certain, however, is that the lobbyists at NAR suddenly have a new #1 mission over the summer.  Realtors (as well as licensees who are not members of NAR) may learn by the end of it that political power is in fact their single most important asset.  And maybe folks would come around to seeing that HouseLogic, and not RPR, is the most significant initiative launched by NAR last year.

Some Questions for Real Estate Brokers

So I’m curious to hear from those who are in the trenches day in and day out.  How important is the mortgage interest deduction to homebuyers?  Is it something they mention when discussing how much to pay for a house?  Or when they’re trying to find a house?  Or is it completely irrelevant by the time someone has entered the market?

Do you ever find that you have to point out the mortgage interest deduction when discussing the pros and cons between renting and buying?  Is it persuasive to most people, or only those really right on the fence?  Does it matter whether you’re in a luxury market (where the buyers are likely to be in high tax brackets and have larger mortgages = larger deductions) or in a low-income market?

Inquiring minds want to know.

-rsh

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  • http://lvtfan.typepad.com/ lvtfan

    I wonder how many brokers hype the supposed income tax benefits of homeownership to buyers who are too naive to realize that they won't benefit from them at all, or won't benefit for long, and/or are too polite or too embarassed to argue.

    Don't forget that the real estate agent works for the seller, not for the buyer, even if the buyer is operating under a different assumption. The agent is there to make the deal happen, not to protect the interests of the buyer. He/she is never going to tell the buyer that the possible income tax deduction might not be of any use to them.

    The standard deduction for a married couple is $11,400. If property taxes are $3,000, interest would need to be $8,400, which at 5% interest would require a $168,000 mortgage principle to make itemization worthwhile. If property taxes are $5,000, interest would need to be $6,400, which would require principle of $128,000. If we accept the old rule of 28% of gross income for PITI, and recognize that first year principle payments are trivial, and call insurance $0, $11,400/.28 requires a gross income of about $41,000.

    Supposed tax benefits make a very nice fudge factor for people who aren't sure they can afford a particular house. The agent can murmur sweet nothings about those potential benefits. By the time the following April rolls around, or rather the first April after full January-December year rolls around, and the tax benefits don't show up, the commission will have been paid, as will the fees to the mortgage broker and title insurer (and its agent, the lawyer) and lots of others who benefit as part of the FIRE sector, including the seller.

    Isn't the Mortgage Interest Deduction wonderful? See how it fires our economy? (See what it does to the unsuspecting?)

  • http://twitter.com/dreamcatcherAZ Randy Hooker

    @Ivtfan – Not all real estate agents and brokers represent sellers. There are buyer's agents and buyer's brokers in this state you assist and represent the interests of the buyer, their client, exclusively.

    Also, in the state of Arizona it is not the place of real estate agents or brokers to counsel real estate clients on tax and/or legal matters. It could and would be a gross breach of ethics and law for us to do so – and to counsel my clients on the possible income tax advantages or disadvantages of home-ownership is IMHO WAY beyond my area of expertise.

    @RobHahn – The income tax deduction for mortgage interest has not one time in my 13 year career ever been a major consideration or issue with any of my clients. Yes, it's been brought up in casual conversation, but I've never seen it be the motivating factor behind a client purchasing a home.

  • http://twitter.com/ARDELLd Ardell DellaLoggia

    HI Rob,

    A while back I wrote a post on “the never ending homebuyer tax credit” addressing this issue:

    http://raincityguide.com/2009/12/16/8150/

    Now that the government and the housing industry has learned that buyers of homes value cash up front, in hand, more than the long term mortgage interest deduction, they would be wise to make a change.

    I don't think you can retroactively cancel the deduction for people who purchased homes in the past. But I do think it is time for a one time election for either an up front tax credit OR a long term mortgage interest deduction.

    It's not even a question, Rob. Buyers clearly get all starry eyed and giddy over thousands of dollars today, vs the mortgage interest deduction. Though in all fairness, the mortgage interest deduction is a buy factor in the rent vs buy scenario IF and only if, rents are equal to mortgage payments. I do not work in one of those markets…but much of the Country falls in that category.

    An irrevocable election at time of purchase for the cash today or the long-term deduction, would be a smart move for government officials to get behind.

  • http://twitter.com/BLarsonMpls Brian Larson

    @Rob: From the standpoint of economic theory, I don't think there is any doubt that completely getting rid of the mortgage tax deduction would reduce housing values. The reason is simple:

    1. The mortgage tax deduction reduces the cost of ownership for those holding a mortgage. It effectively reduces the interest rate on a qualifying mortgage. Thanks to the mortgage interest deduction, a mortgage payment (PITI) costs $x per month instead of $x + $y (where $y represents the effect of the interest rate reduction).
    2. Most consumers who will buy homes with mortgages benefit from this reduced cost of ownership.
    3. Given that consumers are often concerned about how much they can afford for housing on a monthly basis, reducing the cost of ownership in the form of the mortgage deduction allows the consumer to pay a higher purchase price for the home.
    4. As other consumers are in the same situation, they too are willing to pay more.

    How big the effect would be, who can say? But I believe that it's not likely that low-income folks (or even us middle income folks) are much helped by the deduction. The current situation represents a market distortion because it makes prices higher than they should be and it favors purchasing with a mortgage rather than cash.

    I doubt we'll be seeing the end of it any time soon, though, as politicians will be afraid of killing the housing market.
    -Brian

  • Severinus

    I keep seeing the argument that the MID enables home buyers to purchase more expensive houses than they otherwise would buy, and that it's an unfair subsidy to home buyers. That may have been true years ago; however, I think that the benefit of the MID to home buyers is greatly exaggerated. The MID has existed for decades, and at this point, it's baked into the sale price of houses in the higher cost markets on the East and West Coasts (and Chicago). Sellers have been able to charge more for houses because of the MID, and conversely, we buyers had no choice but to pay more for houses because of the MID. The MID raised the purchase price I paid for my house by several $10k, and eliminating it would knock several $10k off of the (already deeply depressed) value of my house.

  • Severinus

    I keep seeing the argument that the MID enables home buyers to purchase more expensive houses than they otherwise would buy, and that it's an unfair subsidy to home buyers. That may have been true years ago; however, I think that the benefit of the MID to home buyers is greatly exaggerated. The MID has existed for decades, and at this point, it's baked into the sale price of houses in the higher cost markets on the East and West Coasts (and Chicago). Sellers have been able to charge more for houses because of the MID, and conversely, we buyers had no choice but to pay more for houses because of the MID. The MID raised the purchase price I paid for my house by several $10k, and eliminating it would knock several $10k off of the (already deeply depressed) value of my house.