Why the Mortgage Interest Deduction should be Eliminated

The fiscal-cliff decision that was reached on New Year’s Day dramatically changed existing tax laws and applied tax breaks for most taxpayers.  The lawmakers have always considered eliminating the mortgage interest deduction to become a source of revenue.  With the hardships that the housing industry has endured over the past five years, lawmakers feared that eradicating the deduction would prolong the industry’s decline.  Why is this a big deal?  Well, first it’s important to fully understand the mortgage interest deduction and what it means:

Understanding the Mortgage Interest Deduction

The mortgage interest deduction permits taxpayers to write off mortgage interest as an itemized deduction.  Interest on up to one million in total mortgage debt is deductible.  Before the Tax Reform Act of 1986, interest on all types of personal loans was deductible.  Since 1986, mortgage loans were the only exception in an effort to promote home ownership.

So why is the time to act now?

The Time to Act on the Mortgage Interest Deduction is Now

Individuals who are proponents of the deduction believe that it is key to keeping home prices up.  When considering high-cost areas, interest can be very significant; the deduction can cut interest costs by more than a third.  When considering the fragile housing recovery, eliminating the mortgage interest tax deduction could really shake up the housing market.  However, here’s something to consider:

• Because mortgage rates are at all-time lows and home prices are depressed, interest that individuals have to pay is extremely low and might not even save anyone anything on taxes.  The standard deduction for joint filers is $12,000 and if the only expense that can be itemized is mortgage interest, the deduction won’t provide any benefit at all.
   
• People are paying cash for their houses more and more frequently.  In the state of California, 1/3 of all homes are purchased without any mortgage.  Paying even as little as 3% interest isn’t a good idea for those who can pay upfront. 
   
• While many homebuilders argue that getting rid of the deduction would be harmful, the biggest impact would most likely be on higher priced homes.  Therefore, homebuilders who focused on lower-priced homes would likely not see any effect at all.  Several homebuilders have been preparing for the rise in rentals that would most likely occur if the mortgage interest deductibility were to be eliminated.

Gretchen Wegrich

Gretchen Wegrich is an editor at Lender411. She specializes in mortgage basics, personal finance and green living. She graduated with a bachelor's degree in writing from University of California, San Diego and previously worked at the Santa Cruz Sentinel. Contact her at gretchen@lender411com.