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On the Deductibilityof Mortgage Interest:

Allowing individuals to deduct the interest they pay on their mortgages and home equity loans, no matter what, but not on regular loans, must rank up there with the worst public policy moves of all time. The rationale for allowing tax deductions of mortgage interest payments is to encourage home ownership, which is reasonably thought to have positive societal externalities. By contrast, allowing individuals to deduct their interest payments when they refinance for a much higher sum than their original purchase price, and to deduct home equity loan interest, actually encourages individuals to put their home at risk. As a recent housing shopper with sharp internet research skills, I was amazed at how many individuals who should have had their original mortgage completely paid off instead owed hundreds of thousands of dollars from either refinancing or home equity loans, often almost as much or more than the house was currently worth. Unfortunately, many people bought into the demonstrably false mantra (wasn't anyone paying attention in the late '80s and early '90s?) that "housing prices never go down," and just kept taking more equity out of their home every so often, usually for present consumption, on the theory that they could always refinance again if they ran into trouble repaying their loan.

The newspapers are now full of stories about families that are losing their homes after refinancing or taking out home equity loans. How much dumber can a social policy be than to encourage, through the tax code, individuals to risk title to their house so they can finance SUVs, cruises, and the like? If anything, home equity loans and cash-back refinancing should not be deductible and loans for cars, boats, and vacations should be. At least then, the government would be encouraging individuals to take loans that carry much less risk to themselves and their families; having your SUV repossessed is a far cry from losing your house to foreclosure.

Good luck:
Good luck to the politician who attempts to repeal the credit. Who wants to be seen as raising taxes AND being against home ownership? The only way this is getting fixed is if there's a wholesale re-write of the tax code in which all sacred cows are slaughtered.
8.25.2007 10:20pm
happy lee (mail):
OMG, what a horrendous crime for the Government to let some people keep some of their money! Quick, call out the National Guard.
The real problem, as suggested by Professor Bernstein, is that the Gummint' gosh darn eliminated most other middle class deductions. And when there's only one big deduction left, is anyone surprised that as many people as possible take advantage of it? Duh?
Taxes are theft. Vote Ron Paul.
8.25.2007 10:41pm
Tony Tutins (mail):
David, you are just so completely right about this. As many things do, this started out well-intentioned: In the 80's, tax reform was supposed to make things simple and fair by eliminating the host of deductions that had been finagled into the tax code over the years. But the mortgage loan deduction was indeed seen as a sacred cow; the foundation of our home-owning culture. But as soon as loan interest deduction was limited to mortgages, people tried to make all their loans look like mortgages, leading to the home equity line of credit with the dread consequences you describe. (In another departure from prudence, RV dealers marketed their vehicles as true homes on wheels, with deductible loan interest.)

Before the mid-80s, the only common use of mortgage "cash-out refinancing" was for building additions to the home. To me, deductible mortgage interest should be limited to "buying, building, or improving" one's residence, with two exceptions: Straight refinancing, to get a lower rate, for example, or to drop PMI; and hardship cash-out refinancing. This last would have kept a lot of the dot-com casualties in their houses, by providing a source of cash to make payments with, till they got back on their feet.
8.25.2007 10:45pm
rfg:
Loans for cars, boats, vacations, etc. used to be deductible, until the last round of tax code "simplification" in the 80's which eliminated these deductions. The deal was supposed to be something like this- tax breaks that went to most of us were eliminated in excange for a reduction in the overall tax rate. In reality of course, the tax rates were lowered, and the deductions that favored the well-off returned.

Kind of like the same deal where we paid extra into Social Security to build up a surplus That would be there when we retired...
8.25.2007 10:53pm
Tony Tutins (mail):
rfg: as someone who lives within his income I don't want to pay higher taxes to subsidize people who are living beyond their means. I agree that the well-off have spent the past twenty years sneaking deductions back into the tax code.
8.25.2007 11:03pm
The Real Bill (mail):

The rationale for allowing tax deductions of mortgage interest payments is to encourage home ownership, which is reasonably thought to have positive societal externalities.
Wrong. All the deduction does is inflate housing prices. Repeal the deduction, but do it over 30 years, a little bit at a time. That way, people currently holding mortgages won't be too pinched.

Low interest rates also inflate housing prices. With higher interest rates and no interest deduction, housing prices would be lower. Monthly payments would be higher (per dollar borrowed), but saving 20% down would be easier.

Government has an interest in inflating housing prices; Higher property tax revenue being only one.
8.25.2007 11:24pm
DavidBernstein (mail):
Bill, I said that home ownership is reasonably thought to have positive externalities, and that this is the rationale used for deductibility of interest. I didn't say that deductibility actually accomplishes that goal.
8.25.2007 11:27pm
A. Zarkov (mail):
"The rationale for allowing tax deductions of mortgage interest payments is to encourage home ownership, which is reasonably thought to have positive societal externalities."

Does the deduction even do that? People buy houses based on what they can afford as a monthly payment. If interest rates go up then the price of houses must fall. If the mortgage interest deduction were repealed then the price of houses must fall to compensate for the effectively greater monthly payment. Of course current homeowners who bought based on the old tax code would suffer, but we could grandfather in the deduction and not allow it for new equity loans. A house should not be some kind of subsidized ATM machine.

It's a similar situation to government loans for college tuition. Lower the interest rate on the loans and tuition goes up, or the amount of aid from the college lowered. Almost any kind of student aid really gets transferred into the coffers of the universities. Do we really want to do this? Aren't Harvard and Yale rich enough?
8.25.2007 11:28pm
Greedy Clerk (mail):
Does the deduction even do that?

It clearly does encourage home ownership --- paying 3000 dollars in interest in equivalent to paying less than 2000 in rent.

The mortgage deduction is also a huge advantage that the well-to-do have in the current tax code.
8.25.2007 11:47pm
Zacharias (mail):
Y'all are pretty silly. The tax deduction for mortgage interest is good policy, since without it we'd all be landlords and renters instead of homeowners.

Every landlord gets to write off all his expenses, including mortgage payments, the usual upkeep expenses and depreciation! The latter two are denied the homeowner, somewhat distorting the housing market. How can mortgage interest be denied him without distorting the housing market entirely?
8.25.2007 11:49pm
Gene Hoffman (mail) (www):
One important factual point here:

RVs, boats with kitchens and toilets, and second homes are all already interest deductible.

In the general household, the only interest that isn't deductible is credit card, auto, and small boat loans, as well as general unsecured debt.
8.25.2007 11:53pm
Jaynie59 (mail):
None of what's been said in the comments so far reflect my real life experience with the three houses I've bought in my lifetime.

What was said in the original post is true. There is this misconception that housing prices never go down, and many people apparently believe that to be true. I guess I was lucky that the first house I bought did go down in value. I remember at the time that my friends told me I was just unlucky. That things like that NEVER happen. Well, it happened to me.

I bought my first house in 1988 when the interest rate was 10 1/4 %. I bought it straight out, with no incentives of any kind. I may have gotten some kind of a "first time home owner" break, but it wasn't much. I paid $79,900 for it and I put $10,000 down, so still had to pay the PMI.

I sold it 5 years later for $67,500 and even after paying the mortgage for 5 years I still owed money when I closed to pay off the principle. I had to pay about one month's mortgage payment, or about $800. (It's a good thing I put $10,000 down or I would not have been able to sell it at all).

By then, in 1992, the interest rate was 7 1/4%. After that experience I never assumed I would make any money off a house. So I just looked for a nice place to live that I could afford. I never planned on moving ever again. As has been said, all I cared about was the total monthly mortgage payment and whether I could afford it.

According to the mortgage lenders, I could "afford" up a $150,000 mortgage. But I knew there was no way I could really afford that. And still eat. So I limited my search to the $100,000 range. I found the perfect house for $100,000 and with the lower interest rate my mortgage payment only went up about $100 a month. I put 5% down, still had a PMI, got twice the house in a much better neighborhood, and my mortgage was about $950 a month. That I could afford.

I really lucked out with that house. Fate took a turn and I ended up having to sell it to move to another state. I sold it 11 years later for $190,000, and bought another house in a very high demand area for $228,000. Again, if I had listened to the mortgage people, I could have bought a $400,000 house, but I knew I couldn't afford that and still eat. So I bought a dump for $228,000 and then put $110,000 dollars into it. That $110,000 came from my 401K and credit cards.

After the renovations, I refinanced the house for $310,000, and paid off all the credit cards. I got a rate of 6 3/4%.

That was two years ago. Now? The house is worth about $250,000. If I'm lucky I may be able to get that much for it. So two out of three houses I've bought decreased in value.

I don't know what interest rates are now and I don't care. You pay whatever it is if you really want a house. It's the monthly payment that really matters. I don't care if I can deduct the interest. All that does is give me a bigger refund every year. I already make sure I have my W4 so that I won't owe anything. I declare Single 0 and then when I do my 1040 I can put down Single Head of Household with 2 dependents. Me and my kid.

I really resent this whole attitude that we have to bail anyone out. Have people lost the ability to do simple math these days? Just because a mortgage company tells you they will give you a loan, does that absolve you of the responsibility to put pen to paper to figure out if you make enough money to pay it? And still eat?

If you're too stupid to do the math, why should I bail you out?
8.26.2007 12:11am
A. Zarkov (mail):
Every landlord gets to write off all his expenses, including mortgage payments, the usual upkeep expenses and depreciation! The latter two are denied the homeowner, somewhat distorting the housing market.

This is like saying we should get to deduct the cost of gasoline because taxi owners can do it. Owning a home is not a business venture. If you rent out your home then you get to deduct all the expenses from the rent revenue you get. Deducting for depreciation also makes sense because houses and buildings do wear out. Any capital gain (most of which is inflation) is taxable when the property is sold. If you convert the house back to residential use then you will suffer a stepped basis equal to the depreciation you took.

To repeat-- the mortgage interest deduction inflates the prices of homes and raises your property taxes. Why do people think rising residential home prices is a benefit? It's just another form of inflation, which most people think is bad thing. And BTW the Bureau of Labor Statistics does not include home prices in its market basket of goods. It uses rents as a surrogate for housing costs, and as we all know, rents have been flat to declining over past ten years while home prices have more than doubled. If BLS did the calculation correctly the rate of inflation would have been much larger.
8.26.2007 12:26am
Guest44:
Doesn't seem like anyone has mentioned yet, but all debt interest--consumer spending, mortgages, etc.--should theoretically be deductible. (It's negative income.) But for some reason people don't seem to think that's fair so we get the current mess.
8.26.2007 12:40am
Matthew J. Brown (mail):
I agree with the posters above - the only thing that remains constant is the amount of money you have to spend on housing per month. Deductible mortgage interest just means house prices go higher. Lower interest rates just mean house prices go higher. Exotic financing that makes people think they can afford more expensive houses just makes house prices rise.

Higher house prices don't make you richer in many real-world ways. They make realtors richer. They make homebuilders richer. They make parcels of land cost more, which is good if you're selling. They increase your property tax payments. Since one still has to have somewhere to live, money sunk into a house is money put away when you can't get it.

Sure, your kids will inherit - eventually. However, THEY still need to live too, and they'll probably, with modern lifespans, not be too young when they get that inheritance.

If you're willing to constantly be moving to cheaper areas every time you sell, you might (timing willing) make a little money. Is it worth it?
8.26.2007 12:51am
A. Zarkov (mail):
housing prices never go down

This graph by economist Robert Shiller shows it all. The inflation-adjusted price of a standard home goes up and down, but it's mostly flat up to 1998. After that the graph rockets up. Nothing shows more clearly than this graph that we have experienced an unprecedented housing price bubble.

Now I think it's true that the median house price is virtually monotonic, but for a variety of reasons this is deceiving. First the general level of inflation has been positive since WWII. Then the size of houses has grown over the years. Once a 2000-square-foot place was a large house, now it's a small house. Houses now come with two and three car garages and central air conditioning and many other amenities. That's why Shiller uses a "standard" house. Finally the increase in the median price is not the same as the median of price increases. The median can go down when every regional medium goes up because home prices and sales are not geographically homogeneous.

Nevertheless most everybody seems to think that house prices must go up as though it were some kind of natural law. But a whole lot of people are going find out that prices can come down over the next ten years. Right now renting is about half the cost of buying, does anyone think this gap is sustainable?
8.26.2007 12:58am
Tony Tutins (mail):
Doesn't seem like anyone has mentioned yet, but all debt interest--consumer spending, mortgages, etc.--should theoretically be deductible. (It's negative income.) But for some reason people don't seem to think that's fair so we get the current mess.


It was twenty two years ago today
Ronald Reagan wanted lower taxes to pay,
Fifty percent was way too high,
So some deductions were gonna have to die,
So may I introduce to you,
The plan you've known for all these years,
Ronald Reagan's Lower Tax Rate Plan.

No more three martini lunches,
State taxes would wouldn't count
All dividends would be taxable
But a higher zero bracket amount.

We're Ronald Reagan's Lower Tax Rate Plan.
Rosty did a lot of it you know
Ronald Reagan's Lower Tax Rate Plan.
'Twas a step towards the flat tax, fo' sho'
Ronald Reagan's Lower
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8.26.2007 1:20am
Mtg Behaviorist (mail):
BUSINESS WORLD
By HOLMAN W. JENKINS, JR.
Payback
August 22, 2007; Page A14

references Carolina Katz Reid's work
"Achieving the American Dream? A Longitudinal Analysis of the Homeownership Experiences of Low-Income Households,"
Thesis draft

on the limited benefits of homeownership to the households that have been shoe-horned into nominal home owner roles in recent years, and are now popping out of that role at growing rates.

Holman's article concludes:

"For the sake of people trying to climb into the middle class, let's hope that one lesson will be a rethinking of policies designed to saddle them with money pits. The Democratic presidential contenders are currently outbidding each other in ways to help "homeowners" (a dubious term in the present instance) avoid foreclosure. What might really benefit these citizens is being freed to return to renting, where some real bargains will likely be had in the months and years ahead."
8.26.2007 1:30am
David Chesler (mail) (www):
Agreed Guest44 -- if positive interest earned is income, why shouldn't interest paid come off income? (I've never gotten an answer from the "flat tax is so simple you can file it on a postcard" -- what about cost of good sold?)

I paid off my student loans during the only years that student loan interest wasn't deductible (and when I took the loan the government-meddled interest rate assumed it was deductible.)

I knew folks who lost money on condos in the 80s. And we've seen neighborhoods go to crap. But I wish I had bought my home as an investment when I bought in 1996. It's a modest 1955 6-room 1.75-story with a detached single garage, and it had already risen in price by about 50% since the late 80s, but it's easily worth 2.5 times what I paid for it; a couple of years ago I probably could have gotten 3 times. Even without the deductibility of mortgage interest, my mortgage (interest and amortization, they dropped PMI a few years ago) plus property, water and sewer taxes are less than rent on a much smaller apartment with no yard. (Suburban Boston has particularly high costs of rent versus cost of ownership.)

Jaynie59 -- as an American, thank you for the free loan.

Tony Tutins -- borrowing against appreciation is pretty obvious, but otherwise most homeowners spend an awful lot on upkeep and maintenance -- lots of home equity borrowing could easily be buried against that.
8.26.2007 1:31am
The Real Bill (mail):
Sorry, David! I misunderstood you to mean that the "rationale" was reasonable.
8.26.2007 1:52am
Tony Tutins (mail):
most homeowners spend an awful lot on upkeep and maintenance

Really? I don't. I may spend time, but I haven't had to spend any significant amount of money. When I needed a new roof, I paid cash. Same when I needed a new fence. I clean my own house and I cut my own grass. Paint is cheap, and carpet lasts a long time. One reason I didn't want to buy a condo is that I couldn't imagine where the association fee was going.
8.26.2007 2:05am
JBL:
Actually, most of the people who (arguably) need assistance with their housing don't itemize their deductions, so they get zero tax benefit from the interest deduction. What they do get is an artificially inflated housing market. And possibly higher taxes, since any deductions lower the taxable income base. I have never seen a remotely credible argument in favor of keeping the mortgage interest deduction, and some very good ones in favor of getting rid of it.



But I'm not sure I agree with the notion that the tax code encourages risky home equity financing.

Collateral doesn't have much to do with whether a borrower should be able to repay the loan. Debt/Income does that. And credit history is an indicator of how the borrower is likely to handle their debt and income. What collateral does is reduce the bank's risk in the event of default. At that point, the borrower has already stopped paying, it's a question of how much their problem will drag down other people.

Home equity financing, assuming it's done right, often makes sense. It's a lower interest rate than most other collateral types. In fact, it's often at a lower rate than the average return on long-term investments. There are all kinds of scenarios in which a person who could just as easily pay cash may want to finance that SUV or vacation.

It is true that losing your house to foreclosure is not the same as having your car repossessed is not the same as getting nasty letters from unsecured creditors. But far be it from me to mandate which is preferable to every citizen, especially when there are real costs involved.

And frankly, I'm not at all convinced that any assets should be insulated from default, at least not until they're close to the bottom rung. There's something fundamentally dishonest about the mentality that "I'm not going to pay back the money I owe, but that's ok because they can't take my house". That sort of thinking probably doesn't do the consumer any favors in the long run.

Do you happen to know how many people who go through a foreclosure actually end up homeless as a result, as opposed to simply finding housing that better fits their means?

To me, the question isn't whether or not the tax deduction puts somebody's home at risk instead of some other asset, it's whether it encourages people to commit to a higher debt/income ratio or less favorable terms than they otherwise would - and I would guess that it usually doesn't. Or if it does, it's a problem with the borrower or the lender or both, not the tax code.
8.26.2007 2:50am
Laura S.:

if positive interest earned is income, why shouldn't interest paid come off income?

Because two wrongs don't make a right. interest earned shouldn't be "income" either. I direct you to Pollock (157 U.S. 429 (1895)) for an at length discussion of a very old idea.

Mind you of course that the language of the 16th amendment essentially allows congress to assign an arbitrary meaning to the term "income" which is precisely what has now happened.

Such things tend to cloud our thinking. Especially when a large crowd of lawyers stands up to tell us what income means as a present-term-of-art in the law.
8.26.2007 3:10am
A. Zarkov (mail):
"Mind you of course that the language of the 16th amendment essentially allows congress to assign an arbitrary meaning to the term "income" which is precisely what has now happened."

A good insight and there are examples beyond interest as "income." If you buy a zero-coupon bond (a bond that has one payment at maturity) the IRS will "impute" an income to you each year and tax it. Thus you will be taxed for money you don't receive. This significantly lowers the rate of return. Another example is an "equivalent income" the Treasury uses for national policy. This is an income that adjusts for the fact that homeowners don't pay rent by adding the value of the rent to the income. Thus when the Democrats say they will not raise taxes for incomes less than $200,000, they are most likely talking about "equivalent income," so it really means a lower amount. Bill Clinton engaged in this deception and once a reporter caught him on it. So when a politician talks about "income" ask him which income he means.
8.26.2007 7:21am
A. Zarkov (mail):
Supplement to prior post.

The UK and other countries tax imputed rental income to homeowners. In the US the state of Wisconsin taxed it until 1917. From time to time American economists have recommended the taxation of imputed rental income. You can read more in an article that appeared in The Journal of Finance in December 1960. The first page of the article is here.
8.26.2007 7:37am
Jaynie59 (mail):
To David Chesler:

Yes, unfortunately, I did need to buy a house in Massachusetts and the market was crazy. I did not want to buy. I wanted to rent. I had already sold and bought a house at the same time and I was determined to NEVER go through that ordeal again. So I planned on selling my house in RI, and renting in the Worcester area, and then taking my time finding another house.

But I had three problems: 1) I smoke. 2) I have 2 dogs. 3)I couldn't afford the rents anywhere near here even if I gave up smoking and got rid of my two dogs. The average rent was $2500 a month.

So I did it again: I went through the hell of selling and buying at the same time. It was just the nightmare I expected it to be. I lost out on two great houses, even though I offered more than the asking price, because the sellers sold to renters who had no contingencies. I was not an attractive buyer because I had to sell my house first. Never again. I'm never moving again, but if I ever have to I will NEVER try to sell and buy at the same time.

You're welcome for the free loan. I know it's dumb. But I also know me. I know I am not capable of saving enough to to pay my taxes if I ever owed money. So the peace of mind of knowing that I over pay every week is worth it to me. And that refund every year is like found money.

I renovated my bathroom with it last year. It came out great.
8.26.2007 8:29am
Public_Defender (mail):
As Tony Tutins pointed out, it was Ronald Reagan who removed the deduction from non-mortgage interest. He wanted to finance tax cuts for more wealthy Republican donors.

Just another part of the real Reagan legacy.
8.26.2007 8:42am
anon252 (mail):
Ronald Reagan and a Democratic Congress.
8.26.2007 9:56am
Gaius Marius:
Blaming the tax code is red herring. The problem is that consumers are trying to keep up with the Joneses next door via purchasing brand new SUVs for the two kids as soon as they get their driver's license, family cruises, cottages up north, boats, 3500 square foot homes for a family of 4, designer clothes, birthday parties with clowns and pony rides for the kids, graduation parties with catered food and 150 person guest lists, limo rentals for the kids' proms, etc. If a middle class family can afford the foregoing without living beyond their means, then all the power to them (I just hope they are also fully funding their 401K and/or Roth IRAs in the process). However, many middle class families can only afford the foregoing via racking up credit card debt and then tapping their home equity to pay off the credit card debt and then using the remaining proceeds to continue funding an unaffordable lifestyle.

It seemed like there was a time when being thrifty was not only necesssary but also something to take pride in. For instance, there was a time when a 1600 square foot home was sufficient space for a family of four, when a family of four had at most two cars and not one for every member of the family who had a driver's license, when birthday parties were simply celebrated with a cake and family, when going to the prom meant asking Dad for the keys to the family car instead of expecting a limo rental, when going on a family vacation meant helping Mom prepare tuna fish sandwiches for a road trip to the nearest national park, when clothes didn't need to have designer labels on them that merely add a $100 to the overall price for clothes that are stitched together by underage kids in Guatemala anyway for pennies. However, I don't think the tax code quashed the foregoing era and values. The more likely culprit is just plain envy of the Joneses next door who acted like they had tons of money but in actuality are swimming in debt and don't have a penny saved toward retirement.
8.26.2007 10:25am
Thales (mail) (www):
I completely agree that singling out mortgage interest for deductibility is bad policy (and ineffective, for the same reason that "tax-exempt" municipal bonds are--the value of the average deduction gets impounded into the price of the object financed with debt).

However, in standard income tax theory, "income" is "accession to wealth," (otherwise known as consumption plus or minus the change in savings) and that accession to wealth is what should make up the taxable base. The principal of any loan is not "income" because it is offset by an equivalent obligation. Similarly, the interest paid on ANY debt should be excluded from income for the same reason: it is the cost of funds to finance the obligation. The income related to an asset such as a home comes only from rental or any net gain from proceeds on disposition (a capital gain).
The real perversity is that by (after 1986) selectively allowing only certain kinds of interest as deductions, we encourage only certain kinds of debt as "good debt." As David points out, it's nothing short of crazy to take out a secured loan on the blithe assumption that the asset securing it will always increase in value. Why wouldn't we just encourage these people to take out a regular unsecured loan for higher interest, or better yet not borrow more than they can afford to repay at all?
8.26.2007 11:17am
Joel B. (mail):
I gotta agree with Zacharias. Why should landlords get to deduct their mortgage interest but not homeowners who are landlords to themselves. That seems like a bad bias to have in the code. Do it yourselfers get punished, why does that make sense.

Even more however, you only get to deduct the interest on up to $100,000 of home equity debt, so most of the time it's the aquisition debt that's really being deducted.

Short-sighted renters, should not lose sight of the fact that the lack of a mortgage deduction would cause distortion. (Currently renting myself, but I'd like to think not short-sighted.)
8.26.2007 11:51am
Just Dropping By (mail):
I hate to be troublesome and ask for facts, but every time a posting is made here about the mortgage interest deduction people rotely intone that the deduction doesn't help rates of homeownership because it merely makes housing more expensive. However, this is only true if the "make-up premium" (or whatever one wishes to call it) equals or exceeds the value of the tax deduction. Is there actual evidence that this is the case? Because the value of the deduction beyond one year into the future is impossible to precisely forecast and varies by individual, I would be extremely surprised to find that the premium manages to track it closer than 10% or so.
8.26.2007 12:01pm
Houston Lawyer:
I thought the purpose of the policy was to stop subsidizing credit card debt with a tax deduction. The change in the tax law has resulted in the change in mortgage law in Texas. Until recently, you couldn't get a mortgage in Texas except to purchase your home or make home improvements. This was done to protect the homestead from predatory lenders. Since citizens of almost every other state could get a second mortgage to refinance credit card debt, Texans were at a disadvantage tax-wise.

So we've given up traditional homestead protection for the ability to refinance consumer debt with home equity.
8.26.2007 12:04pm
SirBillsalot (mail):
Not to worry. AMT creep will soon take care of those pesky deductions.
8.26.2007 12:27pm
michael (mail) (www):
I could lease a car and deduct the whole thing but I'm more comfortable owning it; so even though I pay more, I live my life the way I am comfortable. If me and the Mexican carrying cash along the border end up paying the Supreme Court salaries, so be it.
8.26.2007 1:18pm
Stormy Dragon (mail) (www):
My biggest concern in this is that, in response to the growing cries to 'do something', the fed is going to bailout the people who bought homes they can afford and then squnadered all their equity on the backs of future first time homebuyers.
8.26.2007 2:04pm
John Thacker (mail):
It clearly does encourage home ownership --- paying 3000 dollars in interest in equivalent to paying less than 2000 in rent.

It encourages living in a home that one has a mortgage loan on. It does not particularly encourage fully owning the title to the home, as the original post notes.

I agree that the well-off have spent the past twenty years sneaking deductions back into the tax code.

Not as much by percentage of incomes as have the middle class.

The AMT doesn't allow deductions, and imposes a flat rate over a large deduction. It hits a greater percentage of households with gross income $100,000 to $200,000 and $200,000 to $500,000 than it does the superrich. Why? The biggest reason is that the mortgage interest deduction is limited to loans of up to $1 million and for primary homes. There are a few others-- the deductions for children are fixed dollar amounts and a greater percentage of income the lower one's income is, and similarly other deductions phase out.

It's one of the great myths out there that the rich don't pay taxes because of all those deductions. The rich pay a greater percentage of their gross income than the middle class, because the mortgage interest deduction and deductions for dependent children are such a greater percentage of income at the middle class level. It's absolutely true that some people who are rich can avoid taxes by doing particularly odd things with their money (a large part of why the AMT was started was because of a few millionaires investing all their money in tax-exempt municipal bonds), but it's nowhere near as widespread as the popular perception.
8.26.2007 2:53pm
Fed Policy+Inflation:

My biggest concern in this is that, in response to the growing cries to 'do something', the fed is going to bailout the people who bought homes they can afford and then squnadered all their equity on the backs of future first time homebuyers.


You should be more concerned that the Fed has been asleep at the inflation switch for some time--my father draws a pension, I know I am worried for him.

CPI using the pre-1993 methodology has been running ~8% for several years. This should be alarming to most people, but somehow it seems to be escaping notice.

AFAIK, if you don't believe me, I suggest you pick up a copy of the Economist from your local newsstand and look on the second to last page at the 'Dollar Index', year-over-year price-level changes:

'All Items: +12.6%, Food: +30.2%'.

Now go to your local library and read back issues, you'll see that those numbers have been pegged above 10% for some time.
8.26.2007 3:20pm
Elliot123 (mail):
It looks like "homeowners" will now displace "working families" as the favored political group.
8.26.2007 4:07pm
dearieme:
We in Britain did get rid off the tax relief on the interest payments on mortgage loans for owner-occupiers: the process started under the Conservatives and was finished under Labour. No-one has had the courage to even suggest bringing back the tax on imputed rental income, our old "Schedule A" income tax.
8.26.2007 4:51pm
Tony Tutins (mail):
We in Britain did get rid off the tax relief on the interest payments on mortgage loans for owner-occupiers


And did house prices drop as a consequence?
8.26.2007 5:01pm
markm (mail):
Over the last 29 years, my wife and I have bought and paid off the loans on three houses - and we've never used the mortage deduction. My wife doesn't work and I'm in a profession that doesn't pay quite as well as lawyering, so the deduction on a mortgage with payments around 30% of my income was never anywhere near as large as the standard deduction. The one time when we had to live where prices seemed unusually high, we rented. (And a very good thing we took a pass on those offers to finance a house with 10% down and payments exceeding 50% of my income. Prices were going down when 2-1/2 years later my employer lost it's defense contract and closed an entire division.)

So the mortgage deduction isn't necessary for ordinary Americans to buy houses, when the houses are reasonably priced. Back in the 1950's when incomes were much lower in real terms, possibly it helped middle class families get into undersized tract houses. Now, where the housing market is reasonable it just helps families with incomes well above the mean buy bigger houses.

I can't speak to the "housing bubble" areas from personal experience, but I suspect it just helps those able (or willing, even if they really aren't going to be able to keep up the payments) to pay a little more to bid up the price until the average American family really can't afford a mortgage - and that it has helped in persuading banks that, if they want to sell mortgages, they will have to get less fussy about whether the buyers can reasonably expect to pay it back through 30 years of job changes, family emergencies, and the occasional illness...
8.26.2007 5:18pm
Andy Freeman (mail):
> Allowing individuals to deduct the interest they pay on their mortgages and home equity loans, no matter what, but not on regular loans, must rank up there with the worst public policy moves of all time.

Whether or not that's true, it's not interesting because the law on deductibility of mortage interest debt is significantly different.

According to http://www.irs.gov/publications/p936/ar02.html#d0e1844 there are significant limits on home mortage interest debt.

If the home-secured-loan money doesn't go towards home acquisition, improvement, or investment, interest on money beyond the first $100k borrowed is not deductible. (There are circumstances where interest for home acquisition, improvement, or investment isn't deductible.)

While there are unscrupulous mortage refiance folk (I'm thinking of Fidelity Mortgage, an affiliate of the mutual funds folk, here) who tell folks that their cash-out refi will be deductible when it isn't, I expect a bit more of a law professor who is unhappy about prices where he wants to live.
8.26.2007 5:27pm
Smokey:
Thales:
I completely agree that singling out mortgage interest for deductibility is bad policy...
Maybe this deduction should be be eliminated in order to correct a bad policy. But on one condition: that all monies forfeited by borrowers as a result of eliminating the mortgage deduction must be returned to taxpayers in the form of lower tax rates. Otherwise, all this talk by the government is just a sneaky attempt to collect an additional, unnecessary tax increase from working Americans to spend on Congress' special interest cronies.

Stormy Dragon:
My biggest concern in this is that, in response to the growing cries to 'do something', the fed is going to bailout the people who bought homes they can afford and then squnadered all their equity on the backs of future first time homebuyers.
It's even worse than that. What's really happening is that irresponsible lenders, who deliberately encouraged Ninja borrowers [No Income; No Job; no Assets] to lie on their loan applications, now want the government [ie: we taxpayers] to bail out the lenders. That's where the real pressure on Congress is coming from: irresponsible money lenders, who don't really give a damn if some poor schmuck goes into foreclosure. Borrowers in forclosure have no voting block. It is the money lenders who are making campaign contributions, as they beg Congress to bail out their greedy butts, with taxpayer loot, from the bad business decisions that the money lenders made.

The federal government should let the chips fall where they may.
8.26.2007 5:41pm
Dick King:

Doesn't seem like anyone has mentioned yet, but all debt interest--consumer spending, mortgages, etc.--should theoretically be deductible. (It's negative income.) But for some reason people don't seem to think that's fair so we get the current mess.


One argument for mortgage interest deductibility is that other loans where the proceeds are invested in a manner where a profit is expected are deductible. If you borrow money to buy a restaraunt it's deductible, even against ordinary income in those beginning years where the business is losing money.

Since housing often appreciates [and the appreciation will be taxed] this seems right.

If mortgage interest were not deductible then it would be added to the basis [as is major expenses such as a new roof], so it woudn't be 100% gain to the treasury.

-dk
8.26.2007 6:18pm
DavidBernstein (mail):
Andy, I have already bought a house, so enough with this "Bernstein is just a bitter renter" stuff, which was old even when I was a renter. As for the restrictions on use of refinancing money, I'm under the impression that these were relaxed, but if I'm wrong, can you direct me to cases in which the IRS has actually enforced whatever restrictions there are? Some huge percentage of Americans have used cash-out refinancing for things other than home improvement, and I've yet to hear any stories about any of them getting unexpected tax bills.
8.26.2007 9:33pm
whit:
"Since housing often appreciates [and the appreciation will be taxed] this seems right. "

actually, no...

the appreciation will NOT be taxed (this appreciation is of course a capital gain) since each person gets a 250k exemption (or 500k for couple) with some restrictions (has to be used as primary residence blah blah blah).

market factors aside, the ultimate tax strategy is to buy a house that will appreciate by 250k. that's FREE profit. no taxes.
8.26.2007 10:57pm
whit:
"AFAIK, if you don't believe me, I suggest you pick up a copy of the Economist from your local newsstand and look on the second to last page at the 'Dollar Index', year-over-year price-level changes: "

how about a picture...?
US dollar index (30 days delayed) since the 70's

USDollar index
8.26.2007 11:02pm
Andy Freeman (mail):
> Andy, I have already bought a house, so enough with this "Bernstein is just a bitter renter" stuff, which was old even when I was a renter.

The word "rent" doesn't appear in my posting. Instead, I said that Bernstein is unhappy about the house prices where he wants to live. That may be an old response, but is it untrue or irrelevant? If it's both true and relevant, then what is his objection?

> As for the restrictions on use of refinancing money, I'm under the impression that these were relaxed, but if I'm wrong,

One would think that a law professor opining on a legal issue would respond to a cite with something more than an impression. (We peasants don't have free lexis/nexis/westlaw, a difference that those with said access have happily used to their advantage in the past.)

> can you direct me to cases in which the IRS has actually enforced whatever restrictions there are?

Bernstein was complaining about the rules. Oops - the actual rules are not unlike the proposed improvments, but the promised effect didn't occur.

I'm willing to agree that better enforcement might make a difference, but let's see the argument that new rules will be enforced more effectively. Or, maybe Bernstein will argue that new, albeit similar, rules will work with the current enforcement, enforcement which Bernstein suggests may be too lax to make a difference.
8.27.2007 12:06am
DavidBernstein (mail):
Andy, we seem to agree that in practice, borrowers can take as much as they want out of their house, and that the ultimate issue is that this sort of thing is deductible, unlike regular loans. This is an economic, not a legal matter, though new law, or changed enforcemnt of existing law, can obviously improve or worsent the situation, just like anything else.

The rest of your comments are snark for the sake of snark; the rule, the way you claim it is, is nothing like the proposed improvement, which would be to do away withthe deductibility of anything but an initial mortgage loan, or perhaps that too. And no, I'm not upset about price where "I want to live". I already own a house, where I want to live. Why would I be upset about the prices other people have to pay? I'm rooting now for prices to be stable until just before I want to sell, at which time they should rise suddenly and dramatically.
8.27.2007 12:29am
Gideon Kanner (mail):
Can somebody explain why the comparatively few people owning million-dollar houses should be subsidized by taxpayers most of whom live in homes worth less than half that amount?

No, I'm not of the soak-the-rich school. I merely note the absurdity of the situation whose political irreversibility illutrates Parkinson's third law: it's easier to get into things than out of them.
8.27.2007 1:22am
Brian G (mail) (www):
you are absolutely right. We all need to be protected by the nanny state from our own excess. Plus, our money is better off being sent to the government rather than kept by us. I say end the deduction now so the government can get what's rightfully theirs.
8.27.2007 2:45am
A.C.:
The mortgage interest deduction is a pretty steep slope for those of us who haven't bought houses yet. It inflates prices, as has been noted, and it also does nothing for people who are trying to save down payments. If the deduction went away and tax rates were lowered for everyone, a renter and a homeowner would pay the same tax (assuming their situations were otherwise equal). As it is, the renter pays more tax and has a harder time saving. Not everyone is willing to take out the riskier kind of mortgage, and the current tax system penalizes the prudent.

To put it another way, the better you make any given status, the harder (or, alternately, riskier) it will be for people who don't currently have that status but who are trying to achieve it.
8.27.2007 9:22am
Tony Tutins (mail):
[the mortgage interest deduction] does nothing for people who are trying to save down payments.

Our northern neighbors have a good idea: Canadians are allowed to withdraw $20,000 each from their RRSP, the equivalent of the 401k, to use for a downpayment for a house. They do have to pay it back, however.
8.27.2007 12:51pm
Stormy Dragon (mail) (www):
>Our northern neighbors have a good idea: Canadians are
>allowed to withdraw $20,000 each from their RRSP, the
>equivalent of the 401k, to use for a downpayment for a
>house. They do have to pay it back, however.

The US does that too; in my 401k you're allowed to borrow up to 50% of your account balanace (up to a maximum of $50,000) for a 15 year loan applied to a purchase of your primary residence. The interest rate is prime + 1%, but that goes back into your account along with the principal as your repay.
8.27.2007 2:37pm
A.C.:
Do you pay back with before-tax or after-tax money? If after-tax, what does that do to your tax liability when you start making withdrawals in retirement? Sounds messy to me.
8.27.2007 2:43pm
Joel:
AC: 401(k) loan repayments are made with after-tax monies.
8.27.2007 3:24pm
A.C.:
So you lose the nifty deductability feature of the 401(k). So far, so good (or rather bad). Anybody know whether you pay tax on that money AGAIN at retirement?

In any event, it's hardly a tax-saving feature.
8.27.2007 3:57pm
Elliot123 (mail):
"Can somebody explain why the comparatively few people owning million-dollar houses should be subsidized by taxpayers most of whom live in homes worth less than half that amount? "

Perhaps because those folks in million dollar houses pay so much more in taxes than those living in houses worth less than half as much?

And, I suppose we could also ask why those rich folks are paying to subsidize the housing of all those other people.
8.27.2007 4:38pm
Stormy Dragon (mail) (www):
>In any event, it's hardly a tax-saving feature.

It would have no effect on your taxes. Given the two options of taking $50k from my 401k for 15 years as a loan or taking a $50k loan from a bank for 15 years, my final tax liability when I withdraw from my 401k at retirement is the same. I'm also paying back both loans with after tax money.

What it does save me is paying the interest on that loan to the bank. So the 401k is an advantage unless I think I think I can make much more than the loan rate on other investments.
8.27.2007 4:56pm
Dan Melson (mail) (www):
Actually, in broad, only the costs of acquiring or improving real estate is deductible. Add in another $100,000 for a Home Equity that's also deductible, a tax policy that even I have to question the sanity of (and I'm a realtor/loan officer!)

And the IRS has for the past several months been circulating an advisory that they are going to start enforcing the limits on deductibility that Congress has enacted. In other words, people who have cashed out $200,000 for SUVs and family vacations are going to get hit, big time.

(I covered this most recently in this article)

But I really suspect that this is going to largely curtail the cash-out refinance, the results of which are currently threatening an awful lot of folks with losing their homes.
8.27.2007 5:42pm
A.C.:
Stormy Dragon -

The comparison that's relevant here isn't a 401(k) loan vs. any other bank loan, but a 401(k) loan vs. a mortgage (or rather, a bigger mortgage) with deductible interest. The 401(k) loan may allow someone to come up with a down payment, but it isn't any sort of tax break for the down payment.
8.27.2007 5:47pm
Public_Defender (mail):

Me: As Tony Tutins pointed out, it was Ronald Reagan who removed the deduction from non-mortgage interest. He wanted to finance tax cuts for more wealthy Republican donors.

Just another part of the real Reagan legacy.

anon252: Ronald Reagan and a Democratic Congress.


Yeah, we know that the Democratic Congress had to twist Reagan's arm to get those passed. Geez. Reagan peels off a few Blue Dog Democrats and you blame the Democratic party for the Reagan tax increases?

This is just another example of the Big Lie about Reagan's supposed tax "cuts." If you were poor or lower-middle class, Reagan raised your taxes. But he made you smile as he stuck you-know-what you-know-where.
8.27.2007 10:38pm
Guy in a Veal Calf office (mail) (www):

"allowing individuals to deduct their interest payments when they refinance for a much higher sum than their original purchase price, and to deduct home equity loan interest, actually encourages individuals to put their home at risk"

Good thing individuals may not deduct their interest payments when they refinance for a much higher sum than their original purchase price. You cannot deduct more then your original purchase loan minus principal payments made against it. IRC 163(h)(B)(i)(II):

Such term also includes any indebtedness secured by such residence resulting from the refinancing of indebtedness meeting the requirements of the preceding sentence (or this sentence); but only to the extent the amount of the indebtedness resulting from such refinancing does not exceed the amount of the refinanced indebtedness.

Ask your CPA what the most violated provision of teh tax code is and many will point to this.

As for the $100,000 equity line, its wiped out by AMT, which I hope most of you are fortunate enough to be paying.
8.28.2007 2:15am