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Time to Dump Mortgage Interest Deduction?

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November 27, 2012 – Comments (16)

Board: Macro Economics

Author: yodaorange

One of the largest tax items up for debate is the deductibility of mortgage interest. It is WIDELY misunderstood IMO. (SonnyPage and other realtors please forgive me for what I am about to say.) The National Association of Realtors (NAR) continues to spread the gospel about how important the interest rate deduction is to housing sales. I sure hope all prospective homeowners understand exactly what savings if any they will achieve from the deduction.

The value of the deduction has been greatly diminished to the point of elimination mainly due to very low mortgage interest rates. The problem is that the NAR and politicians have not caught on to this yet.

Here are the numbers to illustrate the nominal case:

US Median Home Price= $186,100
Assume 5% down, gives a loan amount= $176,795
Current 30 year fixed mortgage rates = 3.45%
Maximum interest paid in the first 12 months of the mortgage= $6,045
Assume 2.0% property taxes = $3,722

Total MAXIMUM deduction for interest and taxes= $9,767

Current standard deduction for married filing jointly= $11,600

So purchasers of the median house MUST come up with an additional $1,833 in itemized deductions BEFORE they get a single cent of tax benefit from the mortgage interest deduction.

The median family income is ~ $50,000, so coming up with an additional $1,833 in deductions in addition to the house payments will be difficult for most people.

Also understand that mortgage interest decreases each year as the mortgage is paid off. Even if the interest paid lowers your taxes in year 1, the effect will diminish each year as the interest paid goes down.

I have found close to zero first time home buyers that understand these simple calculations and that they will get little to no benefit from the mortgage interest deduction.

I have found zero REALTORS that properly explain this to prospective homebuyers. They keep perpetuating the myth of some kind of large income tax savings.

Why don’t we talk about who DOES benefit from the mortgage interest deduction?

Somewhat simplified, the main beneficiaries are the left coast (California, Oregon, Washington) and the right coast (New York, Connecticut, Vermont, Washington DC area). These areas have high house prices in addition to typically high income taxes. They are the main beneficiaries of the mortgage interest deduction.

Middle America, the other ~ 44 states get little to no benefit from the deduction. Yes, I know if you buy a multimillion dollar house in Podunk, Iowa you are helped out, but not many folks in Podunk are buying multimillion dollar homes. Most likely they are buying $100k houses.

We have another us versus them tax debate, however it is never framed in these terms. I am not picking sides, just attempting to make the different sides clearly understood.

BOTTOM LINE (slightly exaggerated) is that only “rich folks” with expensive houses gets any benefit from the mortgage interest deduction. Johnny and Susie Six-pack in middle America get no benefit, and in fact are helping subsidize the housing for “rich folks.” Maybe this is what Americans want, but I am not sure the Six-pack family would support it if they really understood what was going on. . .


Thanks,

Yodaorange

16 Comments – Post Your Own

#1) On November 27, 2012 at 7:06 PM, Melaschasm (57.04) wrote:

Even though it will hurt me a little bit, I want to see taxes stremlined, and including the removal of the mortgage interest deduction will need to be a part of that process.

You make a good point about low wage earners not benefiting from these deductions. 

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#2) On November 27, 2012 at 7:15 PM, SubGuy (96.31) wrote:

A guy on WUSA channel 9 just performed erroneous calculations on the news tonight.  He claimed the average family with a $220K mortgage at 4% would end up paying $2900 more per year in taxes if the mortgage deduction is eliminated.  Of course he did not mention that the standard deduction amount is larger than the interest amount.

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#3) On November 27, 2012 at 7:46 PM, awallejr (79.54) wrote:

There are 2 issues I have with this blog.

1)  You ignore to also consider the other Schedule A deductions that average family will include which would actually put them over the top of the standard deduction such as medical expenses, charitable contributions and misc and work related chargeoffs.

2)  Also you seem to minimize the fact that those east and west coast areas actually contain a good chunk of the population.

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#4) On November 27, 2012 at 7:46 PM, BuyCake (99.78) wrote:

First of all, I agree that not everyone understands the deduction nor do they realize that it may or may not actually apply to them. 

But I would argue that it is actually really easy to find an "additional $1,833" in deductions: the actual interest rate many people have on their loans.  Not everyone has a 30 year mortgage at 3.45%.  I don't.  Try 4.5%, or 5%, or 6%.  Lots of people are current on their payments but can't refinance.  They are easily exceeding the standard deduction if their interest rate is over 5%.

Also, there's no direct correlation between median income and homeownership.  Not everyone making below $50K owns a home, but a lot of people making over $50K probably do.  So it is likely that the deduction is applicable to a lot more people than these cherry picked stats would lead you to believe. 

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#5) On November 27, 2012 at 7:58 PM, kthor (70.40) wrote:

This Article doesn't apply to CA ...

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#6) On November 28, 2012 at 10:52 AM, edwjm (99.87) wrote:

Eliminate deductions?  Start with gifts to "charity," Most of which goes to fund foundations and religious institutions with little of the money actually going to poor people

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#7) On November 28, 2012 at 11:03 AM, EnigmaDude (82.54) wrote:

Comments 3 & 4 make some excellent points.  The median family income is inappropriate as most families making less than 50K do not own homes.  And the large majority of homeowners are in the areas on the two coasts, not living in "middle America".  And most mortgages are being charged far higher interest rates than the record low rates that are mentioned here, which are not likely to last for long.  Also, most middle class homeowners probably don't qualify for the lowest rates available.  I just refinanced last year and was happy to get 4.125% on a 30 year fixed loan.  And my credit rating is "good".

So no, its not time to dump the deduction.  It would be bad politically as well as economically.

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#8) On November 28, 2012 at 11:09 AM, Costanzawallet (< 20) wrote:

The fact that median family income is 50k is just sad.

 What about thoise with interest only mortgages?

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#9) On November 28, 2012 at 11:11 AM, EnigmaDude (82.54) wrote:

And I forgot to mention that in 2012, the average amount of a mortgage went from around $215,000 to $235,000 (according to housingwire.com).  That's a big difference from the $176,795
that was quoted above!

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#10) On November 28, 2012 at 11:18 AM, WarrenKiesel (37.17) wrote:

My theory is that housing prices would take a huge hit because it removes incentives to buy a house. You pay extra in taxes to own property and in fact are taxed on the value of the property, so if you make improvements you'll will be paying even more. 

Where in the DC metro area can you buy a house for anything near the national average? Taxes in Alexandria, VA (home of Motley Fool) run over 7000 dollars a year for a modest home. Without the deduction (over 10,000) dollars in interest, I would pay a good amount more in federal taxes. 

Housing will stagnate as a result. Another case of hard working people who invest in communites paying the freight of the population. 

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#11) On November 28, 2012 at 11:27 AM, Mega (99.96) wrote:

"Somewhat simplified, the main beneficiaries are the left coast (California, Oregon, Washington) and the right coast (New York, Connecticut, Vermont, Washington DC area)."

Fact check - Connecticut, Washington, Oregon, and Vermont are the 8th, 9th, 11th and 18th most expensive states for housing. Source - US Census.

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#12) On November 28, 2012 at 11:30 AM, UtahStockMom (< 20) wrote:

It is ABSOLUTELY time to dump the housing interest deduction!  People (read REALTORS) say that the deduction makes home ownership possible.  Really?  Canada has no such deduction and yet their rate of home ownership is about the same (slightly higher, actually).  So the deduction DOESN'T do that.  So what DOES it do?  IT ENCOURAGES BAD BEHAVIOR.  Instead of encouraging home ownership as a way to make society less transient and more stable, it encourages Americans to make debt decisions based on bad math and to take out more mortgage debt than they can comfortably afford.  "If you can afford a rent payment of $800/mo, when you buy, you'll be able to afford a mortgage payment 20% higher because you'll get back 20% of the money (since you're in the 20% tax bracket)!  Now, let's just get you to sign here...."  And that calculation and that conversation happens every day in every realtor's office in America.  Our country needs to encourage saving and investing and DISCOURAGE debt.  The housing deduction is just another way that bankers are encouraging debt to their benefit. 

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#13) On November 28, 2012 at 11:33 AM, mdk0611 (50.75) wrote:

Nothing like the use of a cherry picked set of assumptions to "prove" your point. 

In addition, what about all the people who are currently under water on their mortgages but have remained current?    Rarely do they have a 3.5% rate, and the interest deduction assists them in stayin current on that debt.  So now we're going to take that deduction away and make things even tougher?  I'm sure an increase in the rate of default and foreclosure will do wonders for the housing market.   

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#14) On November 28, 2012 at 11:56 AM, UtahStockMom (< 20) wrote:

PLEASE NOTE:  There are some people here mixing apples and oranges with mortgage interest and property taxes.  Property tax deductions are one thing and the interest deduction is another.  Completely. Only the interest deduction encourages bad behavior. 

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#15) On November 28, 2012 at 5:17 PM, miteycasey (30.14) wrote:

How about kids? Aren't they $1,000 apiece?2.5 kids is $2500 up to I think $4000.

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#16) On November 28, 2012 at 6:42 PM, awallejr (79.54) wrote:

PLEASE NOTE:  There are some people here mixing apples and oranges with mortgage interest and property taxes.  Property tax deductions are one thing and the interest deduction is another.  Completely. Only the interest deduction encourages bad behavior. 

I honestly don't know what you are talking about.  It isn't apples and oranges since they go hand in hand on Schedule A.  Your argument that somehow borrowing money to buy a home is "bad behavior" is silly.  Bad behavior was when lenders lent 106% financing to borrowers who simply had  pulses and where borrowers borrowed way over their ability to pay regardless of the deduction.

But for the responsible the deduction helps tremendously into entering into home ownership, something I absolutely encourage over renting.

Let's keep sticking it to the Average Joes.  This is one of the few tax breaks they can take advantage of so let's take it away.

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