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Mortgage interest tax deduction: Does it make sense?

Will they take the mortgage tax deuction? A real estate agent shows a houseIn just a few weeks, your opportunity to take advantage of the most recent variation on the homebuyer's credit will expire. By most accounts, this version of the credit, which cost taxpayers a whopping $1 billion per month, was a bust, doing little to actually spur the housing market. While a handful of taxpayers and legislators made noise about another extension, most are inclined to simply let it fade away ... until the next big idea comes along.

Over the years, Congress has created a number tax incentives in the name of increasing home ownership. These incentives have largely been popular with taxpayers even though most taxpayers may not actually see a benefit. The homebuyer's credit is just one example -- only 200,000 taxpayers (out of nearly 154 million taxpayers) reported that the credit actually encouraged them to buy a new home.

The most popular tax incentive to increase home ownership has a similar story. The home mortgage interest deduction, while talked about quite a bit, is an expensive subsidy for a small percentage of taxpayers. Most taxpayers never see a real benefit. And arguably, those who don't see a benefit are paying for those who do.

Humor me for a second.

According to the Tax Foundation, the home mortgage interest deduction cost the government $90 billion in 2007 and was expected to top $100 billion in 2008. In 2009, despite a drastic decline in home purchases, the cost of the deduction was expected to hold steady at $100 billion. Together with the real estate tax deduction, the mortgage interest deduction cost the government more each year in pure dollars (in this instance, in lost revenue) than the entire projected cost of the TARP bailout.

Somehow, though, we've come to believe that the home mortgage interest deduction is worth it because of a romanticized notion that it is a post-World War II incentive to achieve the American dream of home ownership. Only that part isn't quite true: Home mortgage interest deductions have actually been available to US taxpayers for more than 100 years. In fact, most personal debt used to be deductible. That changed in 1986, when, as part of one of the most sweeping tax reforms in American history, President Ronald Reagan eliminated most deductions for personal debt. He kept the mortgage interest deduction, famously promising the National Association of Realtors in a 1984 speech that he would "preserve the part of the American dream which the home mortgage interest deduction symbolizes."

It all sounds great, doesn't it? You can almost hear the national anthem in the background. But, when it comes to the numbers, most Americans really aren't able to take advantage of the home mortgage interest deduction. Despite the relatively high rate of home ownership in the US (about 2/3 of homes are owner-occupied), more than 60% of taxpayers do not even claim any itemized deductions on their tax returns.

For those in the middle class, the home mortgage interest deduction generally results in a tax savings of less than expected. Most taxpayers believe that the savings are much higher than they actually are. However, when you do the math, it doesn't always make good financial sense.

The numbers bear out that middle class taxpayers really aren't the ones benefiting from the deduction. According to the Joint Committee on Taxation, more than half of the total mortgage interest deduction is claimed by those reporting income of $100,000 or more, or about 10% of taxpayers. Those taxpayers, who would likely buy a home even without the benefit of the home mortgage interest deduction, tend to get the benefit of huge deductions because they buy more expensive homes. In other words, the reality is that the deduction does not make it easier for most Americans to become homeowners. Statistically, it hardly affects the decision at all. But emotionally, we're tied to the deduction.

Over the last decade, those in Washington have begun to reconsider whether what is effectively a subsidy on upper class housing is the best use of government resources. In 2007, just before the home mortgage crash, Rep. John Dingell (D-Mich.) proposed a law to eliminate the mortgage interest deduction for homes larger than 3,000 square feet. At the time, approximately 10.4 million homes in America measured more than 3,000 square feet, or about 15% of total US housing stock. His efforts to limit the deduction failed.

A couple of years earlier, in 2005, the Advisory Panel on Tax Reform under President Bush recommended completely eliminating the mortgage interest deduction and replacing it with a significantly smaller mortgage interest credit. The Panel also recommended eliminating the deduction completely for second homes and home equity loans. President Bush reportedly favored the recommendations but could not muster support in Congress for the idea.

As recently as last year, President Obama contemplated eliminating the mortgage interest deduction for those making more than $250,000 a year -- and met with loud criticism. The cut would have affected fewer than 2% of taxpayers, but those 2% were likely taking the biggest cut of the deduction overall.

Politically, the deduction is fairly frustrating for both Republicans and Democrats. In terms of budget expenditures versus benefits, it's likely one of the most wasteful deductions in the Tax Code. Getting rid of it altogether would boost revenues significantly with the least impact on the majority of taxpayers. But the threat of eliminating the deduction -- or even reducing it -- has always created a stir. You can pretty much count on the deduction sticking around ... perhaps even for another 100 years.

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Rates have definitely helped keep real estate afloat. However, the real problems are unemployment, uncertainty, confidence in the economy, and tight mortgage lending standards.


September 20 2013 at 3:57 PM Report abuse rate up rate down Reply