Is the Home Mortgage Interest Deduction Worthless?

home mortgage interest deductionAh, home ownership – it is an integral part of the “American Dream.” There are some people who prefer to rent for various reasons, but the vast majority of us have a deep down desire to own our home. We want to be able to call the house ours. Somehow a house feels more like “home” when your name is on the title.

The benefits of purchasing a home are numerous. Some of those advantages include:

  • Building equity through the principal portion of your mortgage payment
  • Potential for unrealized gains via home value appreciation
  • The ability to lock those gains in – most likely tax free – if you sell
  • Not having to answer to a landlord; you’re free to maintain or remodel the property as you see fit
  • Protection from rent increases
  • Being able to deduct your mortgage interest paid when you file your returns thus reducing your tax liability

That last one is a biggie. How swell of the government to make home ownership less expensive by reducing your tax bill, right? The home mortgage interest deduction is touted as one of the biggest perks of owning your home. The residential real estate industry makes sure to market the mortgage interest deduction as one of the main reasons to purchase a home. In fact, the National Association of Realtors (NAR) has this to say about the home mortgage interest deduction:

…“home ownership has been an essential element of the American dream for decades,” and over this time, home owners across the income spectrum have benefited from the mortgage interest deduction. There are those who would have you believe that the mortgage interest deduction benefits only upper-income taxpayers, but that is simply not true. An April 2013 study by the Hudson Institute, which analyzed individual income tax returns in 2007, found that the greatest share of the mortgage interest deduction lies not with the super rich but with the middle class.

Is the ability to deduct your mortgage interest truly advantageous? Is the NAR telling the truth or is it publishing biased opinions? Just how much is it helping Americans?

A Review: What is the Home Mortgage Interest Deduction?

The current form of the mortgage interest deduction has been around since the Tax Reform Act of 1986. The law allows homeowners to:

  • Deduct interest on the first $1 million of mortgage debt
  • Deduct interest on the first $100,000 of home equity debt
  • Apply the deduction to a primary residence and/or second home

Note – the taxpayer must itemize deductions to take advantage rather than elect the standard deduction.

Just How Valuable is the Home Mortgage Interest Deduction these Days?

Let’s take a look at four hypothetical examples to see if there really is value provided by the mortgage interest deduction. Remember, as stated above, you must itemize your deductions to write-off your mortgage interest. If you’re going to go the trouble of itemizing, you’ll likely make some other deductions as well. The biggest of these is probably the property taxes you pay on your home. Since property taxes can vary by state, county, and city, we’ll have to make some blanket assumptions here. Here are all of the assumptions:

  • Loan term: 3o years
  • Down payment: standard 20%
  • Interest rate: 4.32% (the national average per Freddie Mac as of the writing of this article)
  • Property taxes: yearly amounts of 1.25% of the home value
  • Tax Filing Status: Married filing Joint with standard deduction of $12,200 (2013) available to them
  • Purchase price: median sales price from December 2013-March 2014 per Trulia.com

home mortage interest deduction scenarios

As you can see from above, for those living in 3 out of the 4 states, it would not make any sense to use the home mortgage interest deduction because it (plus the rough placeholder for property taxes) is smaller than the standard deduction. Now, I’ll freely admit there are lots of variables that can swing the mortgage interest calculations upward such as less down payment, higher interest rate than the national average, etc. However, the above scenarios are pretty typical of the average home owner and conventional lending standards these days.

Conclusions on the Mortgage Interest Deduction

The mortgage interest deduction is not completely worthless, but it benefits only a minority of home owners such as:

  • Those in high cost-of-living/high property value areas
  • Those who purchase more expensive properties (the wealthy)

For the average middle-class American in most of the country, the mortgage interest deduction appears to provide little to no benefit at the present time. That may change if interest rates climb higher or if property values spike upward. Then again, the standard deduction increases a small amount each year too meaning more interest needs to be paid to exceed it.

But wait, what about the NAR’s statement above about how the middle class benefits more the the upper-income taxpayers? Take notice of the year used for their study: 2007. Yes, that was right at the height of the housing bubble when home prices were drastically inflated and the interest rates were 6+%. Of course, lots of homeowners could use the mortgage interest deduction back then. The problem is the 2007 residential real estate market was not representative of reality. The NAR is sneakily using dated, non-applicable data for their assertion.

With so many homeowners purchasing or re-financing over the past several years, the mortgage interest deduction is seemingly “out of touch” with the common taxpayer.

Should the Mortgage Interest Deduction Stay or Go?

What’s the solution then? Would the country be better off without the mortgage interest deduction? A complete elimination would not phase a majority of taxpayers and could raise additional tax revenue (would essentially work as a “tax on the rich”). If that happened, would the housing market suffer another collapse since the government subsidy would be gone?

What else could be done? Believe it or not, changes to the mortgage interest deduction have been and currently are being discussed by various members of Congress and certain policy institutes. Among the leading proposals is the use of a tax credit instead of the current interest deduction. Remember, a deduction reduces your taxable income while a credit is a “dollar for dollar” reduction in your tax liability. All things being equal, a credit is better although it really just depends how that credit is implemented.

As for me, when I first heard there were efforts being made to get rid of the home mortgage interest deduction, I was staunchly against it. I assumed it was a ploy to increase taxes for most Americans. However, after thinking it through and realizing how few people actual derive benefit from the current law, I am not opposed to possible changes – IF they are handled appropriately. For example, allowing the standard deduction to remain while implementing a mortgage interest credit that could be phased out with higher income levels seems like it might be equitable. That scenario could give a tax break to lower and middle income families while shifting some of the burden to the upper-income earners. Ultimately, though, I remain skeptical of our Congress’s ability to effectively enact useful change. And, if that’s the case, I’d prefer to just keep the status quo rather than having them botch things making it worse for most everyone!

What are your thoughts on the home mortgage interest deduction? Do you use it? Do you think most Americans benefit from it or is the mortgage interest deduction only helping upper income citizens? What changes would you like to see happen, if any?

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26 Responses to Is the Home Mortgage Interest Deduction Worthless?

  1. The Thrifty Issue March 27, 2014 at 6:29 am #

    We don’t have this in Australia. We get deductions on investment properties and there are many things you can claim, but not on the home we own. Interesting read though.

    • Mr. Utopia March 27, 2014 at 2:31 pm #

      You can make deductions on investment properties in the US as well and it can include more than just loan interest. I don’t know much of anything about taxes in other countries, but it doesn’t surprise me that Australia does not have a home mortgage interest deduction.

  2. Little House March 27, 2014 at 6:46 am #

    I haven’t been able to benefit from the mortgage interest deduction since I’m not a homeowner. However, I also didn’t realize that it’s an either/or scenario where you either get the standard tax deduction OR mortgage interest deduction. It seems to only benefit those with higher mortgages.

    • Mr. Utopia March 27, 2014 at 2:35 pm #

      If you elect the standard deduction on your return, that’s it. You aren’t allowed to deduct anything else. Itemizing allows you to list out your deductions by “item.” If you rent, then it’s almost assured you take the standard deduction because, generally, the mortgage interest is the largest deduction when itemizing.

  3. Retired by 40 March 27, 2014 at 7:36 am #

    It is to us! Our interest rate is so low, as is the purchase price of our home that we do not itemize. The biggest itemized deduction we have would be our mortgage interest, which is nothing. Personally, I think they should do away with it

    • Mr. Utopia March 27, 2014 at 2:40 pm #

      Having a low interest rate and home purchase price is better for you than getting a tax break via the mortgage interest deduction, that’s for sure. You are a prime example of why the mortgage interest deduction is “out of touch with reality.”

      Even for those who it can benefit (those who purchase expensive homes), the benefits likely only last a few years. As the mortgage payments become comprised of more principal than interest, deducting the interest becomes pointless because it will drop below the standard deduction threshold before too long.

  4. krantcents March 27, 2014 at 5:21 pm #

    Thanks to the various housing lobbies, I think we will always have a tax subsidy for housing. Soon it won’t matter to me since, I will have my home paid off.

    • Mr. Utopia March 28, 2014 at 1:11 pm #

      Congratulations on almost being ready to pay off your mortgage. It must be very comforting to know you’ll never have to pay for housing again (other than property taxes and maintenance costs that is).

  5. Kylie Ofiu March 27, 2014 at 7:08 pm #

    Another from Australia, so we don’t have it, but from speaking to other US citizens, most have said it should just be done away with.

    Congrats Krantcents on being close to having your home paid off!

    • Mr. Utopia March 28, 2014 at 1:14 pm #

      As krantcents pointed out, the housing lobbies are very strong (including the NAR that I referenced in the article). It certainly faces an uphill battle. I don’t think it’ll ever go away either, but I can perhaps envision some sort of modification to the tax code…maybe one day in future.

  6. Andrew@LivingRichCheaply March 28, 2014 at 7:47 am #

    I live in NYC so yes it would likely benefit me…well if I could actually afford a home. Part of me thinks they should get rid of the deduction. I understand the theory that homeownership is important and adds more stability to communities, but it doesn’t seem too fair. It appears that those with more expensive homes are more likely to benefit from the deduction. Don’t see them doing away with it…lobby is too strong and people will be in an uproar.

    • Mr. Utopia March 28, 2014 at 1:32 pm #

      Yeah, I imagine NYC is one of the few places where nearly every homeowner would benefit from the mortgage interest deduction. Places like San Francisco and Los Angeles are some others. I don’t see them doing away with the law either, but there’s an off chance some sort of modification may be made sometime down the line. I don’t think the subsidy will entirely go away…at least not in our lifetime.

  7. DC @ Young Adult Money March 28, 2014 at 5:09 pm #

    I think it can’t be looked at in a vacuum. It benefits us because we itemize. Just because I gain a benefit from it doesn’t mean I think it’s good policy. I actually think it has to be looked at in a bigger context: that of our entire tax code. I’m all for a flat income or consumption tax.

    • Mr. Utopia March 28, 2014 at 7:58 pm #

      You bring up a good point, DC. The entire tax code could, and many argue should, be overhauled and simplified. That would most likely take care of any discrepancies brought about by the home mortgage interest deduction. I think the mortgage deduction can be looked at in a vacuum though. Individual elements of the tax code are susceptible to being changed. It happens quite frequently it seems. That said, I doubt there will be any true movement on the interest deduction even though some lawmakers and policy institutes are pushing for it. Changing it would be extremely controversial.

  8. Jon @ Money Smart Guides March 29, 2014 at 4:16 pm #

    One other thing, the deduction only helps those in the early years of paying off your house since in the beginning the majority of your payment is interest. As you get later into your repayment, you pay less and less interest.

    I wish more people understood how the deduction worked because I would rather get rid of this deduction and have overall lower tax rates versus keeping things as is. But the big-wigs on the National Realtors Association will fight to the death to keep it alive.

    • Mr. Utopia March 29, 2014 at 5:00 pm #

      That’s exactly right, Jon. Even if the mortgage interest deduction helps you out for the first few years, it won’t be too long before it’s no longer beneficial since the principal-to-interest ratio of the mortgage payments will increase.

      I’d love lower overall tax rates too, but I don’t think that trade-off would ever happen. Even if the mortgage interest deduction somehow was miraculously repealed, I don’t think tax rates would be lowered to offset.

  9. Kay March 29, 2014 at 5:16 pm #

    I like your analysis. I live in a high COL state, so we do deduct our mortgage interest. But I tend to feel that we could get rid of this deduction since I think it is used as an excuse by people and realtors to potentially buy more home than they should because they get the deduction. For the most part, I think people would be better off overall just paying less interest on a smaller mortgage.

    • Mr. Utopia March 29, 2014 at 8:56 pm #

      Another good point about realtors possibly pushing for you to make a bigger home purchase than you should or want to…after all, that means a bigger commission for them.

      I live in a high cost-of-living area as well (California) and, to be honest, for the price of a home that we might be able to afford soon, I don’t think the interest deduction would do us any good. It’d probably be right there on the border, so if it did benefit us it wouldn’t be by much and wouldn’t last that many years.

  10. David March 30, 2014 at 10:50 am #

    Where I live we do deduct our mortgage interest. It would be so much easier in other states, if people just paid less interest on a smaller mortgage.
    Great post!

    • Mr. Utopia March 30, 2014 at 6:22 pm #

      I’d bet in some states with lower cost-of-living and lower home values, there are very few people who are able to deduct their mortgage interest because it wouldn’t help them. That’s not really equitable since their income is likely proportionately lower too. Meaning, they have a similar income to mortgage ratio as those in a higher cost-of-living location, but they don’t benefit from lowered tax bills.

  11. Syed March 30, 2014 at 6:38 pm #

    Great analysis. Many people use the deduction as a reason to buy a house but they might be better off taking the standard deduction in some cases. And it’s also important to remember that the deduction only reduces your taxable income, not your actual taxes. So if you’re in the 25% bracket and you can deduct $20,000 by itemizing, you’re paying $5,000 less in taxes, not the full $20,000. Paying $20,000 in interest in order to get $5,000 back doesn’t sound like a compelling reason to buy.

    Also, I think Congress getting rid of or reducing the deduction isn’t gonna happen anytime soon because the public perception is that this is a great deduction and I’m sure every member of Congress takes advantage of it with their million dollar houses in the DC suburbs.

    • Mr. Utopia March 31, 2014 at 5:54 pm #

      Couldn’t agree with you more, Syed. If someone wants to give me $20,000 in exchange for $5,000 I’m all for it!

  12. Sam April 18, 2014 at 7:38 pm #

    $1 million mortgage on about $250,000 gross income is about what I think is the optimal combination for max deductions.
    Sam recently posted…The Best Time To Buy Property Is When You Can Afford ItMy Profile

    • Mr. Utopia April 22, 2014 at 9:53 pm #

      Could be. It will be extremely interesting to see what parameters are set should efforts to modify the mortgage interest deduction gain real traction and/or become a reality.

  13. Matt June 27, 2014 at 7:53 am #

    Don’t forget that in states with an income tax, like Ohio, income tax paid can also be counted towards itemized deductions. As a result, a much larger percentage of the mortgage interest expense is deductible.

  14. Dyan August 9, 2014 at 5:56 pm #

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