We have all heard of the “fiscal cliff.” For months and years now, the “sacred cow” known as the mortgage interest rate deduction has been bandied about as a sop to “the rich”, and an obvious potential casualty of any deficit reduction “negotiations.”
As a practitioner in the real estate profession, I will begin by saying that our own legislative organizations have done a pitiful job of foreseeing the risk that the MID is likely to be gutted, in not pointing out many of the pitfalls which will occur, and in getting the public opinion away from the nonsense that the MID is a mere “sacred cow”.
The MID is a long-established and accepted factor in the financial decisions of tens of millions of Americans. To reduce these benefits will result in one thing: across-the-board tax increases for virtually all home owners, in many cases significant tax increases. There is no way to sugar-coat this.
Changes in the MID will likely make qualifying for a home loan even more onerous, given after-tax monthly payment calculations will now have to increase. This will take dead aim on housing prices, just as the market is rebounding strongly.
This problem will be exacerbated in the future when interest rates increase. We currently are in an unsustainable period of ludicrously low interest rates. In periods of low interest rates, a home owner not only has a much lower monthly payment, but also more of that lower payment goes to principal pay down, not interest. When rates rise, payments will rise, and the interest component of the payments will rise even further. The table below shows the impact of higher rates on a $200,000, 30 year fixed mortgage loan. The total monthly payment is broken down into principal and interest for the first month’s allocation:
Int. Rate Mo. Payment Mo. Principal Mo. Interest
3.5% $898 $316 $582
6% $1,200 $198 $1,002
9% $1,608 $108 $1,500
Needless to say, higher interest rates will dramatically affect qualifying ratios and significantly impact monthly budgets. For a long time, this negative impact has been buffered in large part by the fact that the calculated interest is deductible to the homeowner on federal income tax tables. It is also taxable to the investor, so it is not as if the taxman does not get his pound of flesh one way or the other. It can be argued that tax revenues may decrease as the overall market declines and fewer people take out mortgage loans, as a result of reductions in the MID.
During periods of higher interest rates, the deductibility of mortgage interest has always been a major factor in keeping the real estate market from total collaps, in many cases. The MID has become an accepted pillar in the financial decision-making and retirement plans of many Americans. Its impact has helped free capital to be spend in local communities. Its removal will be an abrogation of trust built up over decades regarding America’s support for home ownership.
But let’s remove the “apple pie” element and stick to straight economics: removing or severely altering the MID will greatly affect the economics of home ownership for millions of Americans. The marginal impact, which is what drives economic activity, will be far greater than any of the staid current calculated impacts are stating. Less disposable income for an already-strapped middle class (the prime beneficiaries of the MID) will mean fewer bicycles to buy for the kids at the local store; maybe less sporting equipment, fewer books, certainly less entertainment. Now calculate the negative impacts of that on local businesses and how much they will be able to continue to hire workers, etc.
The economy is complex and interrelated. There is not a shred of economic analysis currently out there which in any way fully analyzes the negative impact of draconian changes to the MID. It is the eleventh hour. Somebody needs to speak out. I just did.
Chartered Financial Analyst, CFA