What if the Mortgage Interest Deduction Went Away?

by Xin Lu on 16 August 2011 32 comments
Photo: nikcname

Recently, the United States Congress raised the debt ceiling after a lengthy and ugly debate about spending cuts and tax increases. One of the issues discussed is eliminating or capping the mortgage interest deduction. This deduction is quite popular amongst the American people and is often heralded as the best tax deduction for the middle class. What would happen if it no longer existed?

In the United States, the mortgage interest deduction allows taxpayers who itemize their deduction to deduct the interest of up to $1 million of debt used for buying, constructing, or improving a residence or a vacation home. The deduction also applies to the interest on up to $100,000 of home equity debt. This means that those with large mortgages and high tax rates benefit the most. (See also: The 7-Year Mortgage: Take It or Leave It?)

It is no surprise that a recent report by the Tax Policy Center shows that most of the tax benefits went to wealthy households. For many middle class families that buy an affordable home around the national median price of $184,000, the mortgage interest deduction may be moot because the standard deduction for a couple would be more than the mortgage interest. For these households, the elimination of the deduction would not change their tax liability. Those households that have large mortgages and already itemize will see their taxes go up without the deduction, but these households may just sell taxable investments to pay down the mortgage and break even on their total taxes.

The real estate industry is staunchly against eliminating the mortgage interest deduction because they argue that such a move will drag down home prices when the market is already weak. The deduction is also a great marketing tool for realtors. Practically every realtor I met has touted the deduction as a great reason for buying a home. I think prices may come down a little bit without the deduction in expensive markets where every mortgage holder takes the deduction, but in parts of the country where mortgage interest is smaller than the standard deduction it may not matter that much.

Even if prices drop, I don't think it will be catastrophic since housing prices are already severely depressed and many foreclosures are selling at or below replacement cost. According to the Tax Policy Center report, a little reduction in home prices may even raise homeownership rates because houses will just be plain more affordable, and that is not a bad thing.

If the deduction were eliminated, the Treasury would collect an additional $108 billion in tax year 2012. That is a decent chunk of change that could be used to chip away at the trillions of debt the country has. Although I do take advantage of the mortgage interest deduction right now, I would be happy if it went away because I don't think those who have small or no mortgage should subsidize other people's debt via the tax code. Ultimately, all mortgage interest goes to the banks, and I don't think it is good policy to encourage more debt and inflate housing prices for the benefit of large financial corporations.

What do you think? Do you love your mortgage interest deduction? Do you want it to be eliminated or reformed?

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Guest's picture
Guest

Too many people don't understand how the deduction actually works and that you only get back a fraction of what you're paying in iterest. They see the word "deduction" and they get excited. If you're in the 25% tax bracket and paying $20k in mortgage interest per year, you save $5k, but you're still paying $15k in interest to the bank. You would be much better off to buy an affordable home and pay it off rather than having these huge interest payments.

Guest's picture
a

I suspect the deduction will not go away, though it may be changed. My father told me that after WWII, the government wanted to have as many people as possible be able to be homeowners because, with all the chores, repairs and responsibilities of homeownership, they would be too busy to become Communists. In current times, with people working two or three jobs to keep their houses, they are too busy to work toward changing a system stacked against them. We'll see.

Guest's picture

The combination of mortgage interest and real estate taxes makes it beneficial for us to itemize. We'd lose about $4,000 in deductions if these were eliminated, resulting in about $800 in additional tax liability. If the money were actually used to put the nation back towards solid financial footing, I would not have a problem with that.

Guest's picture
JB

So you would rather pay the bank interest to keep from sending the gov't $800?

Guest's picture

In Australia you don't get deductions for the home you live in. You don't have to pay tax on capital gains when you sell it but there is no deduction on the actual home you live in. Investment properties are a different story, there are plenty of deductions you can claim there, but you also pay 25% tax (approx) on the capital gains.

Our median house price here is over $400,000 so it certainly has not affected house prices being unable to claim a deduction.

I think it would be a good move, especially considering the current debt level and when you factor in it is mainly 'rich' households who get the benefits of these taxes. I am really interested to see what happens in the USA with all these suggestions being thrown around. Thanks for sharing.

Guest's picture
Erin

If the Mortgage Interest Deduction is mainly only benefiting the rich, I'd say do away with it. The middle class is assuming far too much of the tax burden in our economy. Our economy is making the rich their money; they need to support it with tax dollars.

Great related article by warren Buffet in the NY Times:
http://www.nytimes.com/2011/08/15/opinion/stop-coddling-the-super-rich.h...

Guest's picture

I am all for ending the Mortgage Income Tax Deduction but, for once, the Real Estate industry is correct. Eliminating the MITD will lower prices because people will have less to spend but it was NEVER an advantage for the same reason. Basically the introduction of the MITD raised the price of houses artificially so there was never a benefit and, in fact, a huge cash-flow disadvantage.

Look at it this way. If you have $2000 to spend on a mortgage per month you'll buy a certain amount of house. If you add the MITD you can now buy about $2500 of house (assuming you have 20% tax rate, not realisitic but makes the math simple for this exercise). Your spend $2500 and you get $500 back with the MITD. So what happens is a person is now willing to spend 25% more on the same house because they can afford 25% more in monthly payments. Since houses are basically bidding processes enough people compete such that the price goes up to absorb the entire deduction. At the end of the day the person is no better off and actually is worse off because they scrape to find the extra $500 per month and then get relief at tax time with a big check the makes them whole. Instead if they had that $500 on a monthly basis (or got a windfall mid-year that they could have put to something else other than the mortgage payment) they could have invested that.

So the MITD is really either no advantage or a slight disadvantage and really the only people who benefited by it was the banks because they got to charge your $2500 in interest payments a month as opposed to $2000 for the same house. And remember this all becomes moot the minute you start paying principle back in which the MITD goes away for that portion of your payment. Basically the MITD is an elaborate way to encourage the use of bank provided financing and to increase the amount of that financing.

This is yet ANOTHER example of the banks successfully taking advantage of us and all of us gleefully going along.

Guest's picture
JB

You don't get the deduction for the life of the mortgage. At some point the principle exceeds the interest.

Guest's picture
Guest

I can't imagine anyone buying a house solely for the mortage interest deduction. I bought a house because I wanted a house, the deduction was just a minor benefit. I don't want it to go away, but if it does I don't plan to sell the house and start renting.

Guest's picture

Exactly. You made a rational decision based on your own internal needs (and for that you should be applauded). This also explains why the MITD should go away. You are a true "home owner" and not a "home loaner/speculator" who is just doing it for financial reasons. The government shouldn't subsidize personal desire and people should have earn the right to express their personal desires.

Guest's picture
Guest

No no and no. When is enough taxation enough? This country was founded on freedom and a large part of that was freedom from taxation. If you want equality then how about a flat tax for everyone instead of half the citizens paying no income tax at all?

Guest's picture

Uhm technically the country was NOT founded on freedom from taxation BUT actually freedom from "taxation without representation." The founding fathers (and the country at large) had NO PROBLEM with taxation they just didn't want it to be spent without the input of the people who were paying the taxes.

Guest's picture
Joe

If it went away, I would give up on my home and walk away. It's the only reprieve I have every year. I get almost $3k out if it every year, and it makes up for the difference between if I was renting or owning. Take it away, and staying my house that's now underwater from value loss makes no sense.

I can't be alone.

Guest's picture

Nice data point. What you have said is that the value of your house (without the deduction) means that it costs the same to rent vs own your house. That is actually how an efficient real-estate market works and that shows why the MITD is bad. Your house is subsidized by the government to a below efficient price and the bankers are the ones who get the subsidy. Basically you are paying a tax to the banks the the government is paying you back for.

Guest's picture
Joe

@WatchingMarcitz Your point is too vague. This value I'm currently at is in THIS market at THIS point in time in THIS particular location I live. If you go back just a year, everything was different, and the year before that even more so. The data point you're referring to is not a standard, so you can't scientifically deduce much from it.

Other than to say that the last thing we need is another incentive for people to walk away from their homes. THAT is my point. We are where we are, here in this real world, which operates differently than a textbook.

Guest's picture
Joe

@WatchingMarcitz Oh, also, you're deduction from my note was wrong. WITH the credit my rent vs. own ratio is equal right now in this current point in time. WITHOUT the credit, owning is phenomenally more expensive. To the tune of about $300/mo plus about $100/mo insurance. So $400/mo more a month than if I was renting something equivalent.

No brainer for me to walk away should the credit end.

Guest's picture
David

Most people in their 20s would benefit from a home with respect to their taxes. My mortgage payment including escrow is substantially less than if I was trying to rent the same house. In addition for most individuals with one w-2 job who purchase a home, the mortgage interest is enough of a deduction on the schedule A to push you into itemizing rather than the standard deduction. You're forgetting that taxes paid like the amount that gets withheld on your w-2 goes on there so having that deduction does help homeowners most of the time. I know I'd like to have it for as long as I can!

Guest's picture
Guest

David, what you're saying is true. A lot of the times the mortgage interest deduction pushes people into itemizing instead of taking the standard deduction. However, that's a point that a lot of people don't seem to understand and they believe that what they are saving is whatever their tax rate multiplied by the mortgage interest. Suppose that you're a married couple and you used to take the standard deduction of $11,400. Now this theoretical couple buys a house and the mortgage interest is $7000 for the first yeaar. Now this mortgage interest deduction pushes their itemized deduction to $13,000. They are actually only an extra tax benefit of (13,000 - 11,400) * their tax rate, not $7000 * their tax rate. I think a lot of people don't realize that their mortgage interest tax benefit is smaller than they think.

Guest's picture
Theresa

I don't get a deduction since my house is paid off. However, I do know that the net benefit of it isn't worth much. I would rather have a lower payment and no deduction.

Guest's picture
Purchase Wisely

Why, why, why is the assumption always that it is a couple who owns a home? I am a single person who has owned (first a condo, then bought up to a single family home 12+ years ago) for over 20 years. With a single income, the deduction makes a large difference on my taxes each year, enough to push me into itemizing over taking the standard deduction. I did not buy a home just to get the mortgage deduction, but it has certainly helped me keep it over the past few years with a job loss and then a new job at a lower salary. While I could see this being taken away to raise more money for the government (whether people want that or not - the politicians seem to be increasingly out of touch with their constituents), doing so when the economy is in such bad shape seems like a terrible idea.

Guest's picture
Michele

I know that in MY market (Los Angeles), the complete elimination of the deduction would cause another crash in the real estate market. I am not currently a home owner, but if I could take advantage of that deduction, it would be more affordable for me to own than rent because I would be able to lower my tax withholdings. I calculate that I could pay an additional $600 per month in mortgage than I do for my current rent ($1300 per month) and have more money to spend at that. And that is being VERY conservative with my numbers. Take away this deduction, and those middle class people who DO have access to it would have to tighten their spending significantly. In this recovering economy, is that a risk worth taking? I favor capping the deduction at a much lower level, and making it only for the mortgage on one's primary residence.

Guest's picture

If the deductions dont serve the masses, then maybe it shouldnt be there? Maybe not abolished, but most definitely an update/tweak is necessary. More so now than ever?

Guest's picture

I think a lot of people panic about the idea of the deduction going away without really understanding how it will impact them personally. 108 billion is a lot of money to add to the budget!

Guest's picture
juggler314

I'd be a hypocrite if I said it can't go away because I'm all for major tax overhaul. It would definitely drive me into bankruptcy - my mortgage interest and property taxes alone constitute about 25% of my gross pay, throw in the 10-15% that comes out pre-tax and it rises to more like 34%. If that went away overnight I simply would not be able to afford my housing payments.

I would be amenable to phasing it out over time (10-20 years).

Guest's picture
Lydia

I don't buy the argument that the mortgage interest deduction only benefits the rich. The rich will buy higher priced homes, so will have higher deductions.

My husband and I are pretty solidly middle class. Our home is nowhere near the national average, but we live in a low cost of living state. The mortgage interest deduction, combined with the deduction for real estate taxes always is greater than the standard deduction for two people.

It's a big incentive to owning a home. It, along with building equity, was a deciding factor in my purchasing a home at the age of 24 rather than renting.

Guest's picture
Guest

Me too, Lydia.

Another consideration is that by itemizing taxes, I can further tweak the balance by deducting other things that previously I couldn't. For instance, without the mortgage, there's no way I could deduct the charities I donate.

I'd guess if they take away the mortgage interest deduction, we'll see donations drop quite a bit.

Guest's picture

To he point about Charitable donations dropping. I posit that they would go up because house prices would be lower. People would have more money every month instead of waiting for some big refund at the end of the year.

Guest's picture
Guest

Fix the government's salary, pension, healthcare, and other fringe benefits to be like the rest of us citizens before hitting the rest of us taxpayers. I am sure we would save a ton of money in getting our government off of their pedestals. Didn't we fight for our independence years ago to refrain from paying taxes to England's royalty? Our U.S. government has created a palace for themselves, and this needs to be taken away ... NOW!!!

Guest's picture
Guest

the mortgage tax deduction does not help only the rich. if you live anywhere on the west or east coasts home prices are high (no where near the average sited in this article).

i really get tired of articles that mention median home prices and what constitutes middle class as far as income. it totally depends on where you live.
2 people making 80,000 a year in our area is totally different that earning that same amount in another part of he country.

two things i would like to point out:

if you take away the mortgage deduction you would be taking more tax money from the coasts (where houses under the amount mentioned in the article are few and far between), who already pay out more in federal taxes than they get back.
i could see this working if this balanced budget that the republicans want would also include a clause about states not taking more in federal money then they give in taxes. that would never pass because it is the red states that take more than they give.

second point:
the mortgage deduction pushes many people up into being able to itemize, which means they can then itemize other expenses, such as charitable donations and some spending for work items etc etc. if we did not have the mortgage deduction we would not be able to use other lower amount deductions.

Guest's picture

But without the MITD house prices would be lower. So to get those extra deductions you are paying a very hefty fee probably way in excess of your itemized deductions over the standard deduction. Let's face it any charitable donations above 500 get very close scrutiny by e IRS anyway.

Remember to get that deduction you pay $1 to get 30 cents back. Wouldn't you rather have the whole dollar and get nothing back?

Guest's picture
JB

You don't buy a house for the tax deduction. With the historic low rates, most people won't even have enough interest to itemize. YOu can give away the same amount to charity you are giving to the bank in interest and get the same deduction.

Guest's picture
Guest

I think you are a Democrat.
Spread the wealth, it's not worth it to over achieve. Everyboedy gets the same....right?

-From you guessed it, a real estate investing Republican who is tired of paying high taxes for free loaders who sit on their tails. To get the real estate, one needs to work hard and that hard work is ALREADY taxed enough.