Matthew Ferrara, Philosopher

Eliminating the Mortgage Interest Deduction Could Save the Housing Industry

Could eliminating the mortgage interest deduction create a stronger housing industry? Definitely, if you focus on the of the future, not the traditions of the past.

Why does Warren Buffet think it’s right to be fearful when others are greedy, and be greedy when others are fearful? Because it’s un-common sense that often leads to the greatest opportunities.

That’s why I’m contrarian when it comes to saving the mortgage interest deduction. I learn from the past; not simply preserve it. I’m okay with asking, what might happen if we moved on? Other industries repealed their subsidies, and grew stronger. New Zealand farmers did it in the 1980s. They’re growing faster than at any time with subsidies. If farmers, why not REALTORS?

Could we really eliminate the mortgage interest deduction (MID)?

Two Presidential commissions have recommended eliminating it; so, too, many researchers. Of course, the deduction remains popular. Bloomberg notes that 51% of Americans support keeping it. Still, that’s 41% said they’d be willing to give it up.

But doesn’t the mortgage interest deduction help first time buyers convert from renting? That’s seems a fine piece of circular reasoning, that usually comes from a “post-purchase cash flow scenario” compared to renting. You see, you can’t access the deduction if you can’t access homeownership.

And these days, to access home ownership, you need something the MID doesn’t offer: Cash.

Even after home ownership, MID’s effectiveness appears marginal.

It only helps Americans who itemize their federal taxes. Fewer than 40% of Americans dosays the Tax FoundationAmong homeowners, only half do. Of those that itemize, two-thirds have incomes greater than $75,000.

That’s not the profile of a renting first time buyer who need help these days.

What about the unintended consequences of tax subsidies?

Writing off mortgage interest impacts how much people borrow. It certainly didn’t discourage people from borrowing to the hilt last decade. Interest-only loans seem the very antithesis of home ownership. Before the great wars, hardly anybody borrowed to buy a home in America. In the postwar period, the social norm was to put 20% down. By 2010, the typical buyer financed 92% of their home. Some even more with government backing.

Writing off mortgage interest matters, but perhaps not the way we expected.

What’s the MID worth?

An average of $2,000 last year for those that claimed it. But it cost the government around $100 billion in the budget, including the borrowing for it. That’s called taxes.

Can we predict what would happen if MID went away.

I believe we can. In fact, I think the market wouldn’t care. According to the National Association of Realtors August 2011 Confidence Indexnearly 29% of single family home purchases was completely cash. The Boston Globe reported more than a third of homes sold in Massachusetts this year were all cash. Some were investors, but not all. Nearly all of the foreign buyers from Canada and Brazil are using cash to snap up deals in desirable markets, too.

If a third of the marketplace bought homes last year, without the benefit of the mortgage interest deduction, then it tells us that MID isn’t a big incentive for home ownership. 

What is? Cash.

How would eliminating the mortgage interest deduction give more buyers more cash?

Simple: Apply the $100 billion federal budget savings towards lowering their federal tax burden. That instantly puts more cash in more pockets with every paycheck.

Read the tea leaves: Today’s consumers are as careful about borrowing as banks are about lending. We might even return to using cash, if debit card fees keep rising. Certainly, Baby Boomers won’t leverage up again in their lifetimes. They spent much of their home equity on college tuitions; they will hedge what’s left against health care costs. Too many lost it all in the last decade, anyway. As Boomers exit the workforce, it’s cash-and-carry for them.

What about first time buyers?

Today’s college graduates are carrying an average debt load of $30,000. Unemployment and wage stagnation for twenty-somethings means renting a lot longer than their parents. They will remain unqualified for new mortgage debt until they can earn more cash to pay down their existing debts.

The mortgage interest deduction doesn’t address these problems. 

But returning the $100 billion every year to consumers’ paychecks will. Eliminating this (and other) subsidies, and lowering taxes, is the best way to increase everyone’s access to home ownership. Higher paychecks help people sustain mortgages every month. They could even reduce strategic defaults and foreclosures during tough times.

Imagine a tax policy that built business cycle resilience into the housing market by giving people more cash.

Can history guide us?

We know direct buyer tax credits don’t work, so it’s hard to imagine how sustaining the MID will work to increase home ownership. Historically, writing off interest has never been a good idea. Prior to the Tax Reform Act of 1986, credit card interest was deductible. You could buy a TV on your credit card and get a tax rebate from the IRS. We quickly put a stop to that. But we left the job unfinished, with the MID remnant haunting the tax code for more than 25 years.

If we accept that giving away direct credits didn’t work, maybe we need to examine if giving tax deductions really works either. Especially when a third of the market says it’s perfectly fine taking action without it. As long as it has the cash. Tax policy should support the marketplace as it will be in the future, not how it was in the past.

It’s not just home ownership that’s at sake; it’s the future of home sellership as well.

  • Ssaporito

    This is an interesting article, but there is a fatal flaw in the plan. The $100 billion that would in theory be saved by doing this would just be spent by the federal government on something else. That is why we have a $14 trillion national debt. Even if it was returned to the people, that would put less than $300 in everyone’s pocket. That wouldn’t be that helpful.

  • Admitted, it’s a risk; but if we took that approach to every change we might look at, we might a well just throw in the towel, right? I prefer to think from the optimistic perspective that we can do these things; We did in the 1980s; we can do it again.

  • I hear what you’re saying, but the data shows that most of the people don’t actually take this deduction; yes, it lowers some people’s bills, but what if we lowered taxes for ALL (including them).
    Similarly, just because today’s representatives aren’t doing the right thing doesn’t mean we can’t do the right thing. This isn’t an “instant” guarantee but if we don’t start somewhere, then where will we start?
    It’s always hard to imagine government doing the “right” thing, but maybe it has to start with the people who do it – then hold their representatives accountable for doing it themselves, too.
    Thanks for the comment!

  • Catmacgroup

    Hmmmm….most of my buyers, including first time buyers certainly enjoy the deduction. I do, too! This is the only middle class deduction for intents and purposes. Until they change the entire tax code, this is a non starter for me and my clients.

  • Well, that’s the challenge, right? You can’t lower taxes while you keep giving out subsidies. So if you’re not willing to make the first move, then we will be left with subsidies that don’t even keep pace with the tax increases we get anyway.
    Sticking with what we have isn’t a winning strategy for the future, I don’t think.

  • Chantabbott

    I completely disagree with your theory.  It sounds good stating the government would add the 100 Billion back, and eliminate our tax burden’s.  It is very unlikely that will happen.  The tax deduction mostly benefit’s investors. You did not make mention to that.  I have helped many investors purchase investment properties, and that is one of there main motives. 

  • BC3

    Ssaporito has a good point but only the first of two.  Second is what happens to affordability of housing without the MID?  Immediate price reduction of each and every property vis-a-vis comparable price with MID.  Current market structure has MID factored into market pricing and without, the seller has to eat the potential tax deduction from that one buyer who is willing to ante up the purchase price knowing he has a MID.

  • Why are lower home prices bad? We like lower cell prices, lower gas prices, etc?

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  • Guest

    Regarding “Bloomberg notes that 51% of Americans support keeping it. Still, that’s 41% said they’d be willing to give it up.”. Isn’t that 49% willing to give it up?

  • It’s possible its a typo, or it could be that a percentage answered undecided. Check the link to the article… Sorry if its a typo!

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  • Ryan

    I’m with you, Matt. While I can’t disagree with the others as to the likelihood of Congress not spending it and actually applying the revenue towards reducing the national debt or lowering the tax burden…here’s a couple other thoughts:
    1) Lack of a MID hasn’t hampered Canada’s housing industry. You could argue it’s made it stronger.
    2) How much could NAR reduce our dues (instead of increasing them!) if they didn’t waste their time on lobbying to keep this subsidy?
    3) No MID = one less reason for members of Congress & the government to feel they need to over regulate or legislate to manipulate our industry.
    As one of my favorite President’s said, “Whenever you’re in a partnership with the government, you’re always the junior partner.”

  • Excellent points! I think those are right on the mark.


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  • Anonymous

    This comment thread is  a synopsis of the arguments that will surround this issue if it goes forward. I say if, because I think most of the Congress will avoid taking on unpopular issues such as this any time soon. While it is a “tax break” for a few it is thought to be a middle class “right” which, when the debate starts raging again about cuts to entitlements this will be “preserved” by most election fearful members.

  • LBenson62

    Your idealism is cute!  If you believe that the $100B would return in the form of tax breaks given the climate in DC these days then I have some lovely swampland in Florida to sell you.  I agree that SHOULD be the outcome but until I have some certainty of that, I will not be signing on to the repeal of the MID

  • Laura:

    While I understand your cynicism, I should point out that we’ve cut taxes many times before, and experienced decade-or-longer booms as a result. It can be done. It just takes leadership. And a citizenry willing to give up their free lunch today for a better meal tomorrow.
    Somebody has to take the first step: Who will it be? You? Me? The next guy?
    Thanks for your comments!
    – MF