BLOG VIEW: The mortgage interest deduction (MID) has been an unquestioned part of our tax legislation for so long that it’s widely considered an untouchable part of Washington, a sacred monument to lobbyists and special interests held in place with the fear of election-day defeat. Nevertheless, the MID is not what it once was and may soon be a lot less.
As things now stand, the MID has two general forms. First, you can write off interest costs for as much as $1 million in first- and second-home financing. Second, you can write off the interest on as much as $100,000 in other debt that is secured by a personal residence.
However, for a growing number of homeowners, much, if not all, of the MID is irrelevant. What has diminished the MID’s value is the combination of reduced interest rates and bigger standard deductions.
On the interest front, mortgage financing was priced at around 4.2% at the start of the year. That’s not as low as 2012, when rates reached historic lows, but it is remarkably good: According to the National Association of Realtors’ (NAR) chief economist Lawrence Yun, mortgage rates in the 1970s “averaged 8.9 percent; in the 1980s, 12.7 percent; in the 1990s, 8.1 percent; and in the first decade of the new century, they came in at 6.3 percent. The in-and-around four percent rate is only a recent phenomenon, from the year 2011 to today.”
In 2004, the standard deduction for a married couple filing jointly was $9,700. For 2017, the standard deduction is $12,700. During the same period, the typical interest rate went from 5.84% to 4.2%. For a borrower with a $150,000 mortgage balance, the 2004 interest cost was $8,710 versus $6,251 this year. Combine the $3,000 standard deduction increase with a lower interest cost, and for many households, there is no MID worth deducting, especially in jurisdictions with no state income tax, such as Texas, Florida and Washington.
As fewer and fewer people bother with the MID, the electoral price politicians might pay to reduce or eliminate the MID declines. That’s a big deal when you consider that the MID reduced federal tax collections by $75.3 billion in 2016.
How the MID can be reduced
Nobody in Washington is going to launch a frontal assault on the MID – that’s too risky politically. Instead, the idea is to chip away at the MID so the “cost” to Uncle Sam – that $75.3 billion in uncollected taxes – is reduced as much as possible.
One way to cut the MID is to redefine what is deductible. The bipartisan National Commission on Fiscal Responsibility and Reform – known generally as the “Simpson-Bowles Commission” – argued in 2010 for a smaller mortgage interest write-off. Under Simpson-Bowles, homeowners could deduct interest on $500,000 in mortgage debt secured by a prime residence. The proposal – which has gone nowhere – would halve the current mortgage debt limit and eliminate deductions for second homes and home equity lines of credit.
Another approach comes from House Republicans who have offered a “Better Way” proposal to create a “pro-growth tax code.” The proposal outlines an evolutionary approach to reducing the MID.
“This blueprint will preserve a mortgage interest deduction for homeowners,” says the proposal. “The Committee on Ways and Means will evaluate options for making the current-law mortgage interest provision a more effective and efficient incentive for helping families achieve the dream of homeownership. For those taxpayers who continue to itemize deductions, no existing mortgage will be affected by any changes in the tax code. Similarly, no changes will affect refinancings of existing mortgages. But just as importantly, because of the other provisions included in the new tax system, far fewer taxpayers will choose to itemize deductions, with the vast majority of taxpayers finding they are better off by taking advantage of the larger, simpler standard deduction instead.”
Existing mortgages under the plan will continue to enjoy current MID write-offs, but the fate of future mortgages is not explained – an important matter because the typical home loan is now outstanding just 5.5 years.
“Whatever Washington ultimately decides to do with the mortgage interest deduction should be part of a larger, carefully executed program of tax reform,” says Rick Sharga, executive vice president at Ten-X.com, an online real estate marketplace. “Home buyers – and homeowners, for that matter – have built this tax deduction into their affordability equations, much like they’ve factored in rising or falling interest rates, and the cost/benefit of 30-year, fixed-rate loans compared to adjustable-rate mortgages. Simply eliminating the deduction could have the unintended consequence of slowing down home sales in a still-recovering market.”
The implications of the Better Way proposal are significant. One of the traditional attractions of homeownership is the ability to write off mortgage interest, and without the MID – or with less of a MID – some renters may conclude that tenancy is more attractive than ownership, especially if home values are not strong, which is a view that would lead to fewer first-time buyers, less real estate demand and reduced pressure to raise prices.
“The blueprint calls for the standard deduction to be almost doubled from its current levels,” said NAR in a Dec. 16 letter to Speaker Paul Ryan and Rep. Kevin Brady, Chairman of the House Committee on Ways and Means. “The plan also includes the repeal of the deduction for state and local taxes paid, as well as the elimination of most other itemized deductions. Either of these monumental changes alone would marginalize the value of the current-law tax incentives for owning a home.”
A related issue is that now at center stage in Washington are two mortgage “extenders” left dangling with the end of the last Congress. Legislation to make mortgage insurance payments tax deductible and to avoid taxes when a mortgage is not fully repaid has not been extended past Dec. 31.
Will Congress pass the extenders, or will they vanish in the far bigger battle over tax reform? Right now, a lot of people who expected to write off mortgage insurance in 2017 may be in for an April surprise. Worse, people who cannot fully repay their mortgages in 2017 because of a foreclosure or short sale may find that unpaid balances are suddenly taxable.
So, get set for the 2017 Clash at the Capitol. If the current tax system is uprooted, then a number of real estate write-offs might be lost. Whether that’s good or bad for home prices and property sales will depend on the new system that emerges and if it produces smaller overall tax bills.
Peter G. Miller is a nationally syndicated real estate columnist. His books, published originally by Harper & Row, sold more than 300,000 copies. He blogs at OurBroker.com and contributes to such leading sites as RealtyTrac.com, the Huffington Post and Ten-X. Miller has also spoken before such groups as the National Association of Realtors and the Association of Real Estate License Law Officials.