The Truth Behind the Mortgage Interest Deduction

July 30, 2013

NAHB LOGOAs the Senate and the House Ways and Means Committee continue to examine the current tax code in an effort to reform the nation’s tax laws, it’s the perfect time to review mortgage interest deduction (MID) and how it affects current or potential homeowners in Chicagoland.

The home mortgage interest deduction allows taxpayers who own their home to reduce their taxable income by the amount of the interest they have paid on their home loan during that year. The MID was created to help encourage homeownership, and it’s important to recognize how the provision makes it possible for many middle-class families able to achieve their dream of owning a home.

Economists at the National Association of Home Builders (NAHB) have analyzed data from the Internal Revenue Service (IRS) and the Census Bureau, as well as estimates from other sources, to assess the validity of many of the claims made about the mortgage interest deduction.

One of the primary misconceptions about the MID is that the wealthy get most of the benefits. However, the majority of the tax benefits actually go to middle-class households. Data from the Congressional Joint Committee on Taxation shows that 86 percent of households who benefit from the MID have incomes of less than $200,000. It is useful to keep in mind that the majority of home owning households are married couples, so the household income measure will often include two incomes.

While many people feel that repealing the mortgage interest deduction would not affect the economy or individual households, almost all studies examining the elimination of the mortgage interest deduction find that it would reduce demand for housing by raising taxes on would-be home buyers. This reduction in housing demand would also lower home values for current homeowners who would experience a significant loss in wealth. For example, just a 1 percent decline in home prices would result in a loss of $185 billion to American households. And, a 6 percent decline would eliminate a whopping $1 trillion in household net worth. If home values fall, then more families will find themselves underwater, in default or foreclosure.

The mortgage interest deduction is claimed by 70 percent of homeowners with a mortgage in a given year, and almost all homeowners benefit from the deduction at some point during their homeownership lifecycle. The argument that only an estimated “quarter of taxpayers” claim the deduction is misleading because does not take into account the lifecycle element of homeownership. Of the two-thirds of households who own their home, one-third own free-and-clear with no mortgage. And, of those with a mortgage who claim the standard deduction instead of the MID, many are in the final years of a mortgage and are paying small amounts of interest and greater amounts of principal. In the early years of their mortgage when a larger percent of their payment went to interest, those homeowners very likely claimed the mortgage interest deduction.

Many people believe that repealing the mortgage interest deduction would make the tax code more progressive. But in fact, the definition of a progressive tax system is one in which taxpayers with lower incomes pay a smaller share of their earnings in taxes than higher income households. Repealing the mortgage interest deduction would result in a larger percentage of tax being paid by the middle class.

For example, for households with less than $200,000 in adjusted gross income (AGI), the typical mortgage interest deduction is worth 1.76 percent of that family’s AGI. For taxpayers reporting more than $200,000 in income, the benefit falls to 1.5 percent of AGI. Thus, in the event of repeal, middle-class homeowners face a larger tax hike as a share of their income, making the tax system less progressive.

It is commonly mistaken that the mortgage interest deduction incentivizes buyers to purchase a larger home, which easily makes people wary due to the recent economic shakeup caused by homeowners being giving loans larger than they could afford to pay back. While the mortgage interest deduction is sometimes connected with larger homes, evidence shows that what is more often the case is that the tax benefit reflects family size and therefore the housing demand. Larger families generally require a larger home, which in turn means a greater amount of mortgage interest paid and a larger tax benefit. An NAHB analysis of IRS data confirms this. Taxpayers with two personal exemptions, which is a measure of family size, who claimed the MID had an average tax benefit of $1,500. Taxpayers with four personal exemptions had an average benefit of approximately $1,950. In fact, the benefit increased correspondingly from one dependent to five-plus personal exemptions, which is consistent with the notion that larger families require larger homes.

It may seem like common sense to assume that renters do not support the mortgage interest deduction. However, public opinion polling has generally found the MID to be popular with renters, most of whom hope to become homeowners. Given that recent homebuyers receive the greatest tax benefits from the deduction, such renters would have much to lose if the MID is repealed. A 2012 poll found that a majority of renters were opposed to eliminating the mortgage interest deduction.

While anyone can make an argument either way in regards to the importance of the mortgage interest deduction, it is important to weigh the benefits of having the MID and the consequences of repealing it. Many middle-class new homeowners in Chicago have been given the ability to own a home thanks to the MID, and to take it away could result in potential economic hardships for families across the city, state and country.

About The Author

Read All Stories By Mitch Levinson

Mitch Levinson is the author of “Internet Marketing: The Key to Increased New Home Sales” published by BuilderBooks. He is an Internet marketing expert with expertise in search engine optimization, website development, email marketing, social media and CRM consulting services. He is known for creating effective programs that can be tracked through analytics to prove effectiveness and ROI. Mitch is founder and president of MLC New Home Marketing and MLC FlatFee Realty, as well as managing partner of mRELEVANCE, LLC, a Marketing, Communication, Interactive agency with offices in Chicago and Atlanta. He currently leads the Chicago team. A Multi-Million Dollar Sales Producer who earned an MBA in Computer Information Systems and eCommerce, he brings a unique perspective and experience to the field of real estate communications. Mitch combines the two interests in order to help home builders and developers gain a competitive advantage through the Internet and technology. When he isn’t behind a computer, he enjoys participating in sports and coaching his kids’ teams. Mitch resides in Arlington Heights, Ill., a northwest suburb of Chicago, with his family, which includes two rambunctious labs. Visit my Google+ profile.

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