The mortgage interest deduction is as American as apple pie. In some fashion or another, homeowners have been able to deduct interest paid on their mortgages dating all the way back to 1913 – a span of 100 years. Yet, many politicians and interest groups are doing their best to eliminate the mortgage interest deduction. Such a move could dramatically alter the real estate market and have a drastic impact on your annual tax liability. Are you prepared?
The Mortgage Interest Deduction Right Now
The current form of the mortgage interest deduction has been around since the Tax Reform Act of 1986. The intent of the reform was definitely to aid and encourage home ownership. The law allowed 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 tax payer must itemize their deductions to take advantage rather than elect the standard deduction.
Proposed Changes to the Mortgage Interest Deduction
According to a CNBC article, some members of Congress and certain policy institutes are plotting to eliminate the mortgage interest deduction. Why? Well, the simple answer is take more of your money and to increase overall tax revenues! Advocates of changing the law also assert the current mortgage interest deduction only benefits a minority of people and say those that do benefit are high earners (over $100,000).
In lieu of the mortgage interest deduction, many of the new proposals call for implementing a tax credit. 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 tax credit is generally preferable to a deduction. Of course, that depends on how the credit is structured and also on your own unique situation. Among the suggested alternatives are:
- A tax credit ranging from 12-15% of the total interest paid
- Ability to base the credit on loans sized up to $500k (which is half of the current amount on the mortgage interest deduction)
- No need to itemize your deductions (since it is a credit)
- Could possibly remove the eligibility on a second home
What Happens if the Law Does Change?
If a tax credit does replace the mortgage interest deduction, there will be some very real fallout. Here are just some of the potential considerations:
- Do you even use the mortgage interest deduction? Interest rates have been at historical lows for several years now. Oftentimes borrowers have secured such low rates that the interest paid, along with other deductions such as property taxes, are not large enough to exceed the standard deduction. If that’s the case, the loss of the mortgage interest deduction may be no big deal for you. In fact, you might come out ahead if the mortgage interest deduction is replaced by a credit (see immediately below).
- A credit may actually be more beneficial to you. In theory, you should be able to use a mortgage interest tax credit even if you haven’t been able to take the mortgage interest deduction (because you didn’t itemize). Thus, while it will depend on the parameters of the credit, those who do not currently itemize could save up to a few thousand dollars in taxes. On the other hand, people who have been itemizing and who do take the mortgage interest deduction may end up better off as well depending on how such a credit is structured (there will be a break even point somewhere). Of course, many “itemizers” will fare worse.
- The higher end of the real estate market may suffer. The tax bill of those with larger mortgages will go up under the proposed switch to a credit. As a result, purchasing and owning higher end properties will be more costly. This could lead to a suppression in values and sales activity for more expensive real estate.
- Different regions of the country will be hit harder than others. States with higher overall property values, like California or New York, could face a slowdown since there will be less tax benefits to acquiring homes via large mortgages.
- An overall slowdown may occur. Who knows what shape the real estate market will be in if/when such legislation is enacted. If today’s trends of rising interest rates and market values still persist, that could push many would be borrowers into a situation where they are worse off. They may ultimately decide to not purchase or perhaps they will take a longer time in pursuit of a good deal.
What Should I Do?
Nothing has officially happened just yet, so there’s no major action you need to take right now. However, you should definitely stay tuned. As with any bill that tries to make its way through Congress, it could get killed any at time (there are staunch opponents including the the collective real estate lobby which has deep pockets). The fact that party members of both sides, as well as President Obama, want to explore ending the mortgage interest deduction is a telling sign though. Serious momentum could pick up quickly. In the meantime, you can consider:
- Lobbying Your Congressperson – The effectiveness of contacting your Congressperson is debatable, but if you have a strong opinion either way then you should reach out to your Representative and Senator.
- Plan Accordingly (just in case) – It never hurts to be prepared. Right now there are various versions of proposed legislation, so calculating all of the potential impacts is a bit unnecessary. That said, staying abreast of developments and reacting/planning as necessary is advised.
If the changes to the mortgage interest deduction do occur, it will be headline making news and you’ll most definitely hear about it. If/when that happens, don’t be afraid to contact a tax professional if you are concerned how you’ll be impacted. Stay tuned here at Personal Finance Utopia for further updates.
What do you think? Should the mortgage interest deduction be eliminated in favor of some form of a credit? Or are you of the mindset of “if it ain’t broke then don’t fix it”? What other impacts might there be from such a change?