The nation’s capital seems very quiet at this time. The sequester deadline has passed and the budget debate continues, both with little apparent impact. Wall Street is setting records and the economy seems to be improving regardless of what’s happening in Washington.
Beneath the surface there is a very real possibility that the mortgage interest deduction (MID) could be trimmed.
“It may be that with both interest rates and prices so low, this could be the ideal time to redesign the tax subsidy for home ownership,” says Howard Glickman, writing on Forbes.com. “Because monthly mortgage payments for many homeowners and buyers are lower than they have been for years, trimming or restructuring the MID might have less impact than we thought.”
In the past thoughts about ending or reducing the mortgage interest deduction have largely been fantasy, but today at least three proposals now floating around Capitol Hill that would change real estate write-offs as we now know them.
The starting point for all budget discussions is a 2010 report from the National Commission on Fiscal Responsibility and Reform — a bipartisan group commonly known as the “Simpson-Bowles Commission.” The report says mortgage interest deductions should be related to not more than $500,000 in mortgage debt. It also says write-offs for second home interest and home equity lines of credit should be eliminated.
While the Simpson-Bowles group produced a report the study itself was endorsed by 11 of the 18 Commission members, a hint of unlikely prospects for passage on Capitol Hill.
Another approach has been offered by Rep. Keith Ellison (D-MN). Under his plan, HR 1213, borrowers could write off the interest paid on as much as $500,000 in real estate debt — half the current amount — plus $100,000 for a home equity loan.
The twist with the Ellison plan is that it would also grant a 15 percent tax credit for mortgage borrowers. The effect would be to reduce taxes for homeowners in the lower tax brackets while raising costs for those with higher incomes. Ellison says as much as $198 billion could be raised over a decade using the system and that only 4 percent of all homeowners would actually face higher expenses.
Lastly, we come to Barry Habib, chief market strategist for Residential Finance. Writing on CNBC, Habib proposes that rather than reducing the mortgage interest write-off it should be capped after five years and only apply to acquisition financing.
Because of the way mortgages amortize much of the potential interest cost is front-loaded into the early years of the loan. If you borrow $200,000 at 3.5 percent the total potential interest bill over 30 years is $123,312. During the first five years the total interest bill would amount to $33,280.
In looking at the ideas above, Simpson-Bowles is the simplest and arguably the most radical proposal. The end to write-offs for second homes would substantially impact home values in resort areas and second home markets, not a good political approach. Cutting the home equity write-off would also impact the construction industry and reduce the ability to use real estate equity to fund college classes and new businesses, another idea with little political appeal.
The Ellison plan produces actual tax revenues, something the government needs but also something opposed by many members of Congress, especially in the House where, says the Constitution, all financial bills must originate. Still, an idea which raises money yet does not impact many voters has a certain innate political attraction in Washington, enough to give some momentum to the idea.
The Habib approach would effectively allow a five-year period for the tax rules to change, but would also allow opponents to spend five years creating political pressure to extend the timetable or overturn the plan before it could ever take effect. The Habib proposal is an unattractive political mix because supporters could be open to charges of raising taxes while not actually collecting any additional revenue.
While none of the plans mentioned here seems instantly passable, they all point in one direction — smaller write-offs created by reducing the maximum loan amounts from which interest can be deducted. Such cuts would impact few households while at the same time raising federal revenues, an accommodation that might work for all sides of the political spectrum. If the maximum amount loan amount against which interest can be deducted was reduced from $1 million to $729,750 — the largest-available FHA or VA loan at this time — just how many people would object?