You Could Lose Your Mortgage Interest Deduction

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?

mortgage interest deduction

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?

7 Responses to You Could Lose Your Mortgage Interest Deduction

  1. Chuck@Tortoise Banker July 23, 2013 at 9:37 am #

    I personally choose not to use the mortgage interest deduction, even though my wife and I have a home with a mortgage. The standard deduction of ~$11,900 bucks or so for a married filing joint return is more than enough for us. But I’ll definitely follow this topic you mention though.
    Chuck@Tortoise Banker recently posted…Add Saving to Your DNAMy Profile

    • Mr. Utopia July 23, 2013 at 9:18 pm #

      Hey, Chuck – yes, so if the law is ultimately changed to eliminate the mortgage interest deduction and it’s replaced with some form of credit, that could be a positive thing for you and your wife. If this topic gains traction in Congress, I imagine it will be a pretty divisive issue across the country because so many stand to benefit while quite a few would end up in a worse situation.

  2. Daisy @ Prairie Eco Thrifter July 23, 2013 at 5:39 pm #

    We don’t have the option for mortgage interest deduction in Canada. It’s really sad. I wish we did, but I guess I can’t change it.
    Daisy @ Prairie Eco Thrifter recently posted…3 Moves that Can Hurt Your CareerMy Profile

    • Mr. Utopia July 23, 2013 at 9:20 pm #

      Hi, Daisy. I don’t know much about taxes or real estate in Canada. Are there any tax benefits at all to owning a home there?

  3. Sam Gill @ Digital Spikes July 24, 2013 at 9:26 am #

    Well i haven’t take any home mortgage yet. But I would like to remain and i agree why fix things which are not broken
    Sam Gill @ Digital Spikes recently posted…How to write and what to write when short of ideasMy Profile

    • Mr. Utopia July 24, 2013 at 12:33 pm #

      So many households in the US are either homeowners or aspiring homeowners – this issue could conceivably impact a vast majority of the country and quite a few will share that same sentiment, Sam. Thanks for dropping by!

  4. smallbusinessloanMinD July 27, 2013 at 5:15 pm #

    In U.S. the deduction costs the Treasury some $100 billion a year in revenues and many politicians from both sides of the aisle are calling for either the deduction to end completely, have it changed to a tax credit, or limit the deductions for higher incomes, a move President Obama said he supports. Making any kind of changes to the deduction won’t be easy … those in favor of it are gearing up for a bitter battle to the end.
    smallbusinessloanMinD recently posted…Management Accounting Versus Financial AccountingMy Profile

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