Archives for January 2013

A 1913 article in the New York Times commented on the introduction of the mortgage interest stating that Congress “certainly wasn’t thinking of the interest deduction as a stepping-stone to middle-class home ownership, because the tax excluded the first $3,000 (or for married couples, $4,000) of income; less than 1 percent of the population earned more than that;” During that era most people who purchased homes paid upfront in cash rather than taking out a mortgage.

Fast forward to 201, few tax breaks stir as much emotion and are as sacrosanct as the deduction homeowners get for mortgage interest. Although this tax break is not one of dozens set to be on the fiscal chopping block, there is talk of reining it in as part of a broader effort to reduce the nation’s deficit.

This has supporters and foes of the deduction out in force. The housing lobby characterizes it as mom and apple pie. Critics call it a windfall benefit to the wealthy, since it mainly benefits taxpayers with big mortgages in high tax brackets.

Here are some mortgage interest deduction Myths and Facts:

MYTH: The Mortgage Interest Deduction Was Intended To Promote Home Ownership.

FACT: When the federal tax code was introduced in 1913, all interest was deductible. At that time, few Americans except farmers had home mortgages. It was easier to allow a deduction for all interest, targeting home ownership was not a motivation.

In 1986, when Congress overhauled the tax code, it eliminated the interest deduction for most consumer debt including auto loans and credit cards, but kept it for mortgages used to buy, build or substantially improve a home. This exception was a result of intense lobbying efforts of the housing industry.

In 1987, Congress limited the deduction to interest on up to $1 million in mortgage debt on a first and second home. But it also created the home-equity deduction that lets homeowners deduct interest on up to $100,000 in mortgage debt used for purposes other than buying, building or improving a home. This was a back-door way of letting homeowners (but not renters) once again deduct interest on consumer debt.

It’s hard to see how the home-equity deduction promotes home ownership, since it subsidizes people who use their houses like an ATM , thereby depleting their home equity. Even real estate lobbyists have a hard time defending it, other than to say now is not a good time to be messing with the fragile housing market.

MYTH: The Mortgage Interest Deduction Is Wildly Popular.

FACT: In many surveys, it enjoys strong support. In practice, only 25 percent of households that filed a federal tax return in 2010 claimed the deduction, even though the home ownership rate was about 67 percent. To claim it, homeowners must itemize their deductions, but for many, their standard deduction is higher than their itemized deductions combined, meaning they get no benefit from the mortgage interest deduction.

For 2012, the standard deduction is just under $12,000 for couples and $6,000 for singles. In 2012, the median mortgage taken out to buy a home is estimated at $186,000 nationwide. At 4 percent, the interest payments on that loan would be about $7,400 the first year, and less in subsequent years as principal makes up an increasingly larger part of the payment. Without a lot of other deductions, that’s not enough for a married couple to itemize.

Even in California, where mortgages are bigger than the national median, only 27 percent of tax filers claimed the deduction in 2010 .A California Association of Realtors survey of  800 people who bought a home in 2012 found that 79 percent said the mortgage interest and property tax deductions were “extremely important” in their home-buying decision.

FACT: The true value of the deduction is the amount by which your interest payments, when added to your other potential itemized deductions, push you beyond the standard deduction, multiplied by your marginal tax rate.

Suppose you are married and in the 25 percent marginal tax bracket. You pay $15,000 in mortgage interest and $4,000 in state income taxes and make $1,000 in charitable contributions. Without the mortgage interest, you would take the standard deduction – $12,000. With the interest, you claim $20,000 in itemized deductions.

The value of the mortgage interest deduction is $8,000 ($20,000 minus $12,000) multiplied by 0.25, or $2,000. If, instead, you were in the 33 percent tax bracket, the benefit would be $8,000 multiplied by 0.33, or $2,640.

MYTH: The Deduction Makes Homes More Affordable.

FACT: Lenders do not take the deduction into account when they qualify borrowers for a loan. It does reduce the after-tax cost of a mortgage, but whether this makes homes more affordable is debatable. The chief economist with the National Association of Realtors, says home prices would fall 15 percent if Congress eliminated the deduction. Wouldn’t that make houses more affordable?

Suppose you have a mortgage at 4 percent. If you are in the 25 percent tax bracket, your after-tax rate is 3 percent.

If the deduction goes away, your after-tax rate goes from 3 to 4 percent, but if the price of a house comes down, your 4 percent mortgage is based upon a lower mortgage amount. The after tax savings could be a wash.

FACT: According to Internal Revenue Service data, about 18 percent of the mortgage interest deductions claimed on all 2010 tax returns came from California and 6 percent from New York. These numbers are disproportionately large given each state’s share of the population – California is about 12 percent and New York 6 percent.

The debate over the pros and cons of the mortgage interest deduction will continue on. While there may be changes coming in the terms of limits of the deduction, this all American tax deduction is destined to stay.

 

Wallingford PA Real Estate – Wallingford, PA 19086