Killing the Mortgage Interest Tax Deduction

Speculating that the mortgage interest tax deduction might go away is currently quite popular. News sites all across the internet have taken various angles on what it might mean to individual homeowners and the real estate markets in general.

Most articles argue that eliminating this tax break will cause home values to decrease. The National Association of Realtors is frequently quoted as estimating that home prices would fall by 15% nationally and more in areas with higher prices (like Connecticut). The second most common angle is arguing about who actually benefits most from the tax credit – the “1%” or the “middle class.”

We have three observations:

First, nobody knows exactly how eliminating the tax credit for mortgage interest will impact the housing markets. It’s something that has never happened before in the US, so we can’t look back and see what happened last time. This post on The Big Picture blog is the most succinct summary of the history of the mortgage interest tax deduction that I have found, and has some references at the bottom.

We believe any market, real estate or otherwise, is far too complicated to model with any accuracy. So trying to put a number on the impact of one minor change in the dynamics of the market is unproductive since it’s almost certainly going to be wrong.

That said, we agree that no longer giving homeowners a tax break will tend to push prices in the downward direction. Taxes are an annual cash expense for homeowners, and this could make expenses go up. But there’s no way to quantify how much of an impact annual operating expenses will have on buyers.

Second, our impression is that home buyers are not focused on the tax credit they’ll get from their mortgage interest when they buy a home. We work with buyers all the time and don’t hear them trying to quantify their tax break and figure that into their bids. Most probably know that there is a tax benefit to owning real estate, but it seems like a vague notion rather than a hard dollar amount.

Finally, the value of the mortgage interest tax deduction has decreased dramatically in recent years. Part of it has to do with the decline in property values. Lower prices mean smaller mortgages and less mortgage interest. But the more important factor is the historically low interest rates. It’s common for qualified buyers to have mortgage rates below 4% these days. And many have refinanced into shorter loan terms with even lower rates that have meaningfully less mortgage interest.

For example, a 30-year fixed-rate loan at 6.25% in 2004 (our first mortgage) had annual interest of about $15,000. That same loan today at more like 3.50% would only have $8,300 in annual interest. So the rate environment alone accounts for a more than 40% reduction in the tax deduction.

The decrease can be even more depending on the choices you make. Falling rates have allowed us to refinance multiple times, and annual interest on our current loan is less than $6,000 per year. It’s the same house, with a slightly lower principal balance, a much lower interest rate, a shorter mortgage term, and a higher monthly payment. So the market, combined with our personal choices, has reduced our mortgage interest tax deduction by about 60% since 2004.

The residential real estate market will continue to exist and function whether mortgage interest is tax deductible or not; people will still need to buy and sell homes. Changing the rules of the game will always have an impact, but it is impossible to quantify just how much one factor will influence how buyers bid for homes. It’s fine to want this particular program to continue – we all want to minimize our taxes/expenses. But it feels like most are overstating the importance of the mortgage interest tax deduction by suggesting killing it off could ruin the recovering housing market.