How a Revised Mortgage Interest Deduction Could Boost Homeownership and the Economy
March 11, 2013
By Barry Habib
Chief Market Strategist for Residential Finance
Founder and CEO of MBS Highway
... Don’t axe the home mortgage interest deduction. Change it.
As Congress continues to wrestle with how to trim spending, a hotly debated topic is the federal tax deduction for home mortgage interest. And it’s no wonder why, when you consider that the home interest deduction is estimated to cost the federal government $100 billion a year. As a reference point, the fiscal cliff fiasco and hike in tax rates, increased revenue to the government by $62 billion a year. And the highly publicized sequestration is about $85 billion in cuts.
This makes the mortgage deduction a juicy target for elimination ─ especially since legislators feel they will be shielded from lash backs from their constituents by the following surprising statistics:
According to the IRS, only 26% of filers claim the mortgage interest deduction
Only 39 % of homeowners claim the deduction
More than one-third of homeowners own their home free and clear. Of the remaining homeowners who have a mortgage, only 58% claim the deduction
Not in My Back Yard
Obviously, every group will want to defend breaks they receive. And Mortgage and Housing is no exception. But as part of a grand bargain, the mortgage deduction could be vulnerable to elimination. However, such a dramatic move would not come without paying a price and putting the economy at risk. According to the National Association of Home Builders (NAHB), home purchases and the ancillary economic activity generated from home purchases account for nearly 20% of GDP.
The economic chain reaction
The home mortgage deduction can act as a powerful incentive for individuals to purchase a home. This is particularly true for first-time homebuyers who can justify the step-up from a rent payment to a house payment with the tax deductibility of their mortgage. And keep in mind that those first-time homebuyers are very important; they begin the buy-sell-buy chain reaction that helps current homeowners move up to their next home.
The law of diminishing returns
It’s clearly a wise decision to offer the mortgage deduction as an incentive because the increased economic activity more than justifies the deductibility. That said, it can be argued that there comes a point of diminishing returns. Should the individual who just purchased a home remain there for several years, the deduction becomes the “gift that keeps on giving” without spurring economic activity.
Therefore, rather than eliminate the deduction and risk hurting the economy, adjust the deduction so it does what it is intended to do: stimulate home buying. And under a new structure, continue to motivate individuals to purchase a home without giving them a benefit that lasts well beyond its usefulness to the economy.
The five-year tax deduction entitlement
How do you adjust the mortgage tax deduction and still provide an incentive to homebuyers? By giving the deduction a five-year life. This change would mean that after five years of purchasing a home, the homeowner would no longer be entitled to a deduction on their mortgage. However, should this homeowner purchase a new home (not refinance), he or she will have a new five-year period of deductibility on the new purchase mortgage. This keeps the incentive where it is intended to be, which ultimately helps fuel economic activity.
The additional benefits of this plan
This solution is easy to implement because of the simplicity of grandfathering. Individuals with current mortgages will continue to claim the deduction for the next five years, making the effect gradual and allowing individuals time to adapt. First-time homebuyers would still be incented to purchase and realize no adverse effects from such a change.
What’s more, by limiting the tax deduction to five years, we are better protected against a housing slump due to higher future interest rates. This is possible because it may make sense for some homeowners to sell their homes when the mortgage deduction has expired, and move on to new homes that come with a fresh five years of tax deductibility ─ even if mortgage rates are higher.
The inherent value of a well-considered strategy
No matter how politicians feel, deficits need to be addressed. And rather than last-minute panicked decisions and changes, a thorough and thoughtful solution needs to be considered. If those in charge were to utilize the tools at their disposal to create incentives and receive positive returns, it may truly be possible to strengthen our country’s financial condition and ensure a brighter future.
March 11, 2013
By Barry Habib
Chief Market Strategist for Residential Finance
Founder and CEO of MBS Highway
... Don’t axe the home mortgage interest deduction. Change it.
As Congress continues to wrestle with how to trim spending, a hotly debated topic is the federal tax deduction for home mortgage interest. And it’s no wonder why, when you consider that the home interest deduction is estimated to cost the federal government $100 billion a year. As a reference point, the fiscal cliff fiasco and hike in tax rates, increased revenue to the government by $62 billion a year. And the highly publicized sequestration is about $85 billion in cuts.
This makes the mortgage deduction a juicy target for elimination ─ especially since legislators feel they will be shielded from lash backs from their constituents by the following surprising statistics:
According to the IRS, only 26% of filers claim the mortgage interest deduction
Only 39 % of homeowners claim the deduction
More than one-third of homeowners own their home free and clear. Of the remaining homeowners who have a mortgage, only 58% claim the deduction
Not in My Back Yard
Obviously, every group will want to defend breaks they receive. And Mortgage and Housing is no exception. But as part of a grand bargain, the mortgage deduction could be vulnerable to elimination. However, such a dramatic move would not come without paying a price and putting the economy at risk. According to the National Association of Home Builders (NAHB), home purchases and the ancillary economic activity generated from home purchases account for nearly 20% of GDP.
The economic chain reaction
The home mortgage deduction can act as a powerful incentive for individuals to purchase a home. This is particularly true for first-time homebuyers who can justify the step-up from a rent payment to a house payment with the tax deductibility of their mortgage. And keep in mind that those first-time homebuyers are very important; they begin the buy-sell-buy chain reaction that helps current homeowners move up to their next home.
The law of diminishing returns
It’s clearly a wise decision to offer the mortgage deduction as an incentive because the increased economic activity more than justifies the deductibility. That said, it can be argued that there comes a point of diminishing returns. Should the individual who just purchased a home remain there for several years, the deduction becomes the “gift that keeps on giving” without spurring economic activity.
Therefore, rather than eliminate the deduction and risk hurting the economy, adjust the deduction so it does what it is intended to do: stimulate home buying. And under a new structure, continue to motivate individuals to purchase a home without giving them a benefit that lasts well beyond its usefulness to the economy.
The five-year tax deduction entitlement
How do you adjust the mortgage tax deduction and still provide an incentive to homebuyers? By giving the deduction a five-year life. This change would mean that after five years of purchasing a home, the homeowner would no longer be entitled to a deduction on their mortgage. However, should this homeowner purchase a new home (not refinance), he or she will have a new five-year period of deductibility on the new purchase mortgage. This keeps the incentive where it is intended to be, which ultimately helps fuel economic activity.
The additional benefits of this plan
This solution is easy to implement because of the simplicity of grandfathering. Individuals with current mortgages will continue to claim the deduction for the next five years, making the effect gradual and allowing individuals time to adapt. First-time homebuyers would still be incented to purchase and realize no adverse effects from such a change.
What’s more, by limiting the tax deduction to five years, we are better protected against a housing slump due to higher future interest rates. This is possible because it may make sense for some homeowners to sell their homes when the mortgage deduction has expired, and move on to new homes that come with a fresh five years of tax deductibility ─ even if mortgage rates are higher.
The inherent value of a well-considered strategy
No matter how politicians feel, deficits need to be addressed. And rather than last-minute panicked decisions and changes, a thorough and thoughtful solution needs to be considered. If those in charge were to utilize the tools at their disposal to create incentives and receive positive returns, it may truly be possible to strengthen our country’s financial condition and ensure a brighter future.
There was good news for the housing sector, as CoreLogic reported that home prices rose by 0.4% in December, from November, and was the tenth monthly gain. In the year ended in December, prices rose by 8.3%, the largest increase since May of 2006.
