How much tax deduction should you get if you bought this house?
In a full page advertisement in the December 19th edition of the Sacramento Bee, the California Association of Realtors (CAR) hopes to sway public opinion against reducing any deduction of home mortgage interest from federal taxes. Unfortunately, CAR uses misleading statements and NRA style arguments in an effort to save an abused tax shelter and a dinosaur of a deduction. The first line of the CAR advertisement states,
While “home is where the heart is” for millions of American families, it also is where our nation’s economic recovery resides.
Mortgage interest deduction selling point
From the folks that were complicit with inflating the housing bubble of the mid-2000’s, CAR is now asking us to believe they know what “good” tax and housing policy looks like. Pure and simple, the mortgage interest deduction (MID) helps sell houses and that’s what real estate agents do, sell homes. Right after they tell you how much closet space the house has, a real estate agent will launch into the mortgage interest deduction mantra, “…and you get to deduct the mortgage interest off on your taxes.” It’s a psychological selling tool; buy a house – reduce your taxes, what could be a better deal.
Not made in China: U.S. houses
There are parts of our country that manufacture homes like Detroit builds cars or Hollywood creates movies. Home construction can be an integral part of a regions economy creating jobs and opportunity. However, the discussion involving the MID focuses on reducing the maximum allowable amount of interest deductible on mortgage debt of $1 million down to $500,000. Most suburban tract home buyers will not be borrowing half a million dollars to purchase a new home, let alone $1 million.
Most buyers covered by lower MID
As the CAR clearly states in their ad,
In California, 59 percent of taxpayers who claimed this deduction in 2010 had an annual adjusted gross income (AGI) below $100,000, and 89 percent had AGI of less than $200,000.
These folks would not be affected by the MID being lowered. The $1 million dollar MID government gift goes to high income earners and those who have the means to purchase a second home. If you need the MID to justify a $1 million home mortgage, or to purchase a summer house on the lake, you have bigger issues with your finances.
Fear factor
The CAR open letter to President Obama and the U.S. Congress plants the seed of fear that all mortgage interest deductions will be eliminated.
… any attempts to reduce the mortgage interest deduction would not only have deleterious effects on homeownership, but also be tantamount to taking the first step toward a wholesale elimination of the long-standing deduction.
Just like the NRA has successfully linked any gun control legislation as the first step in complete confiscation of firearms, the CAR is also trying to establish a conspiracy theory about the government’s ultimate aim at eliminating the MID. If your congressional representative or Senator benefits from the deduction, they will never vote to eliminate it.
Unsubstantiated claims
CAR continues to play the “fear of the unknown” wild card,
It would slam the brakes on America’s economic recovery by changing the fundamental economics of homeownership for more than 75 million Americans…
Hogwash. The fundamentals of homeownership are not rooted in the MID and the great majority of those 75 million Americans would not be impacted by lowering the MID. In an effort to couple entry level homebuyers to the real recipients of the current MID levels, the ad states,
First-time homebuyers would be forced to delay a home purchase that no longer “pencils out.”
How many first-time homebuyers are securing a home mortgage over $500,000?
What do the numbers look like?
The monthly payment on a $500,000 mortgage for 30 years at 7% is $3,327. If we use a standard rule of thumb that total credit debt and mortgage payment should not be higher than 36% of the gross income, assuming the mortgage is the only financed debt, the $3,327 equates to a monthly gross income of $9,225 ($9225 x .36 = $3,321) or $110,700 annually. Total mortgage interest deductible from federal taxes would be approximate $34,800 in the first year. If the home buyer put down 20% toward the purchase of the home and financed the remaining $500,000, that would make the selling price $625,000. Even in California, a family can buy a very nice home for $625,000 and still deduct all the mortgage interest off their federal taxes under the new proposed lower mortgage interest deduction limit.
Who is CAR really supporting?
The CAR ad finally gets to the constituency they are trying to protect: upper income and second home owners.
Furthermore, should the mortgage interest deductibility be eliminated for second homes, the potential economic losses to the California economy would total more than $557 million.
Since they don’t reference where the $557 million economic loss comes from, I will have to assume that a big portion are the commissions real estate agents make on the sale of luxury and second homes. If you can afford to buy a second home, you don’t need a tax subsidy from the federal government.
Government tax policies distort housing market place
Alluded to, but never fully acknowledged in the ad, is the distorting effect the MID has on housing prices. By admitting that, “-likely would see home prices decline again.” if the MID is reduced, CAR recognizes that MID artificially inflates home prices. Especially for homes that will be financed with mortgages over $500,000, the buyer can calculate how much their taxes will be lowered with the MID and in turn increase their bid on the house. This sort of price inflation is no different than the effect that the “no interest adjustable loans” had on the housing market seven years ago. People will bid up the price of a house based on the cost of their monthly mortgage payment.
What other deductions does CAR favor?
If deducting the interest on a mortgage is such a grand stimulus for the housing market and a boon to the consumer, shouldn’t we be allowing families to deduct the interest from car loans, medical debt and credit cards? Why should the housing market be the only sector of the economy that gets special treatment?
Tax policy for first-time home buyers, not luxury houses
We are finally coming out of a huge correction in the housing market after an almost total collapse. The housing crisis, and subsequent recession, was brought on by faulty asset-backed securities known as Collateralized Debt Obligation (CDO). Fueled primarily by sub-prime mortgages, these CDOs imploded when the home prices artificially spiked by “liar loans” and “house flippers”, which supported the assets, finally fizzled out. Now that the housing market is starting to get back to normal, it’s a good time reduce some of the inputs that cause speculation and artificial price inflation. A reduction in the MID on mortgages of $1 million to $500,000 will still cover the overwhelming majority of first-time home buyers, which is what the tax policy was meant to support in the first place.