Ah, 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:
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
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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