I wrote about the home mortgage interest deduction in detail back in January of 2009 in Tax Policy and Housing:
Debt Subsidies
Debt subsidies, in particular the home mortgage interest deduction, are seen as a great benefit to home ownership. The benefit is widely overestimated and misunderstood.
First, people fail to understand that to obtain a debt subsidy, you must have debt. You must be making an interest payment on this debt in order to qualify, and you get to reduce your tax burden by a small percentage of the interest amount. In short, you are paying a dollar to save a quarter. There are people who actually seek to maximize their interest payments in order to increase this subsidy. This is really, really foolish. Anyone out there who believes it is a good idea to spend $1 to receive $0.25 in return, please send me as much money as you wish, and I promise to send back 25% of it.
Realtors try to con people with the "throwing your money away on rent" argument. Homeowners buy into the fallacy. Interest is the rent on money. You throw away money on interest just like you throw it away on rent. In fact, people who overpay for housing throw away more money on interest than renters do to obtain the same property, even after the tax subsidy. The only argument one can make for paying extra interest is if you are receiving a return on that investment through property appreciation. We all see how that is turning out.
The main reason the benefits of the home mortgage interest deduction are overestimated is because people forget they must give up the standard deduction in order to obtain it. This is one area where tax policy can have hidden and indirect impact on housing. Changes in the standard deduction greatly impact the benefit of the home mortgage interest deduction. As the standard deduction is increased, the positive impact of the HMID is decreased. In fact, if the standard deduction were doubled, the average American holding a $150,000 mortgage probably would not bother itemizing to obtain the HMID because it would be of no tax benefit at all. This would certainly simplify people's tax returns. A higher standard deduction is also a boon to renters who do not have the option of obtaining the HMID.
When we set up the RentVsOwnulator, we put in a 25% tax benefit from the HMID. Some people have commented that this is too small a number. It is not. Several people have run the calculations both with and without the HMID, and the net difference is only 25% even at the highest tax brackets. Basically, if you want to figure out your real tax benefit, take your highest marginal tax rate and subtract 10%. That will be a much closer estimate to reality. This reduction is caused by losing the standard deduction.
Another facet to the HMID is the cap level. Currently mortgages up to $1,000,000 are eligible for the deduction. Does anyone think this is right? Do you realize you as a taxpayer are subsidizing $1,000,000 mortgages? When the GSEs were set up, they established a conforming loan limit. The reason they did this is because they are mandated to subsidize mid and low income housing. Why is the limit on the HMID any higher than the conforming loan limit from the GSEs? Why are we subsidizing high income borrowers?
If we were to reduce the HMID cap level to $500,000 and adjust it by the CPI going forward, we are still subsidizing relatively high income borrowers ($500,000 is still almost triple the median home price in the US). A reduction in this cap would have the same impact as the lower GSE conforming limit is having: it would lower prices at the high end by eliminating the subsidies.
IMO, the government has no place in subsidizing house prices that are well above the median. One can argue that the government should not be subsidizing anything in housing, but the low and middle income subsidies are here to stay. If we raise the standard deduction and lower the HMID caps, we can greatly reduce the impact of the HMID and the cost we pay for it as taxpayers. This would have the effect of lowering prices on more expensive homes, but it would help stabilize the lower end of the market. That is what the market needs right now.
I wonder if anyone on the Obama commission is an IHB reader?
by JON PRIOR -- Wednesday, November 10th, 2010, 4:37 pm
The National Commission on Fiscal Responsibility and Reform, proposed limiting the mortgage interest rate deduction on taxes, one of the primary incentives for owning a home.
Silly me, I thought providing shelter was a primary incentive for owning a home.
President Obama created the bipartisan commission in February to provide options on overhauling the tax system and reducing the national deficit. According to a November report, one option excludes citizens from deducting interest payments on second residences, home equity loans or mortgages over $500,000.
Every Irvine home owner should contact their congressman and demand they resist this option. This tax increase is aimed squarely at the upper middle class wage earners in places like Irvine. It will take both your income and your property values.
Of course, don't expect us lowly renters to give you much support.
Other options would be to tax dividends and capital gains at the ordinary rates. The commission said its extensive plan would reduce the deficit by nearly $4 trillion through 2020. Cutting mortgage interest rates was, expectedly, met with resistence from the housing industry.
Michael Berman, chairman of the Mortgage Bankers Association, warned that now is not the time to be cutting back incentives.
"The mortgage interest deduction is one of the pillars of our national housing policy, and limiting its use will have negative repercussions for consumers and home values up and down the housing chain," Berman said.
Lawrence Yun, chief economist for the National Association of Realtors even told the Wall Street Journal that limiting the mortgage interest deduction would bring on another recession.
"We share the widespread concern over the growing national debt and want to help identify reasonable solutions," Berman said, "but we cannot support proposals that would chip away at the foundations of the real estate market."
Apparently, the California Association of realtors didn't think Lawrence Yun went far enough in his use of ridiculous scare tactics.
by JON PRIOR -- Thursday, November 11th, 2010, 5:03 pm
Santa Clara County Realtors Association President Karl Lee warned that limitations to the mortgage interest deductions a presidential commission is considering would devastate the national economy.
Home prices in the affluent California county increased roughly 6% to $699,174 in October, according to the association. It's up 11% from a year ago. The National Commission on Fiscal Responsibility and Reform, proposed two options in their efforts to overhaul the tax system. One was to reduce how much homeowners could deduct by 20%, and the other was to exclude second residences, home equity loans or mortgages over $500,000.
Each of those ideas are good ones. The impact would be to make debt more expensive and thereby less desireable. Another thing I would add is that they should raise the standard deduction so fewer people would gain advantage from itemizing and taking the HMID.
"This policy will immediately and unnecessarily reduce the net worth of many American households," Lee said.
Reducing the home mortgage interest deduction would certainly take much of the air out of the bubble. It would reduce loan balances, and thereby lower offers of new buyers. This will lower prices for homes in areas where loans exceed $500,000. It would immediately reduce the net worth of homeowners in those areas. However, this policy would not impact anyone else. New buyers would be taking on less debt -- which is a good thing. Renters would no longer be subsidizing the debts of homeowners through tax incentives -- which is a good thing. And tax revenues would increase -- which is why the commission is considering it.
Isn't this objection really an admission that our current system of home values is a debt-dependant Ponzi scheme?
"Limiting mortgage interest deductions will also result in domestic job losses in many core American industries that are directly or indirectly impacted by housing."
Nonsense. Homebuilders can adjust to whatever price levels the market will offer. If you drive around Las Vegas, you see signs for new home developments with houses selling for less than $90/SF. They built and sold the same houses for $250/SF four years ago. The people most impacted by this price change would be owners of raw land who would see their depressed values remain low for a very long time. As long as the resale price of the home exceeds the cost of production, homebuilding -- and all its associated employment -- will do fine.
Santa Clara County is seeing some improvement in the market. In October, more than 1,000 home sales closed, a 4.5% decrease from September, but it was the lowest monthly decrease in five months. The inventory of homes on the market dropped nearly 7% in October.
The lowest decrease in five months is an improvement? That is really spinning.
"Removing a significant homeownership incentive is a short-sided answer to our larger national debt problem, a solution that in reality will drive the country into a deeper economic crisis," Lee said. "Every American, regardless of income status or geography, should oppose limiting mortgage interest deduction."
There are only two consituencies that should oppose the changes to the HMID offered by the commission: (1) homeowners with mortgages over $500,000 -- which isn't very many people, and (2) raw land owners in the path of development -- which is very few people. Everyone else should be in favor of these changes because everyone else is sending their tax dollars to the two effected groups every year through the tax break.
The fear in the comments of the realtors is obvious. The self-serving nature of those comments is equally obvious.
Typical Irvine Ponzi Investor
When people invest in real estate in Irvine, they expect the property to appreciate in value, and they further expect this appreciation to be convertible to cash by a stupid bank complicit in the Ponzi scheme. When house prices rally, this works out well. The investor gets much more money from the property than rents generate, and the bank gets an increasing loan balance, more interest payments, and higher profits. If it weren't for the fact that it is a Ponzi scheme guaranteed to blow up, it is a great arrangement for both parties.
This property was purchased on 4/7/2003 for $383,000. The owner used a $306,400 first mortgage, a $57,450 second mortgage, and a $19,150 down payment.
On 7/15/2004 the owner refinanced with a $412,500 first mortgage.
On 8/29/2007 he refinanced again with a $437,500 first mortgage.
He defaulted about a year later, and squatted off and on for about three years.
Foreclosure Record Recording Date: 06/30/2010 Document Type: Notice of Sale
Foreclosure Record Recording Date: 03/29/2010 Document Type: Notice of Default
Foreclosure Record Recording Date: 04/27/2009 Document Type: Notice of Rescission
Foreclosure Record Recording Date: 12/10/2008 Document Type: Notice of Default
This loan was finally put out of its misery on 8/6/2010 when the property was purchased by a flipper for $426,500. Condos in this zip code are currently selling for $311/SF which would put the price of this property at $511,906. They have already lowered their wishing price once, but they still appear to be about $40,000 over market.
Home Purchase Price … $426,500 Home Purchase Date .... 8/6/2010
Net Gain (Loss) .......... $90,406 Percent Change .......... 21.2% Annual Appreciation … 106.1%
Cost of Ownership ------------------------------------------------- $549,900 .......... Asking Price $109,980 .......... 20% Down Conventional 4.21% ............... Mortgage Interest Rate $439,920 .......... 30-Year Mortgage $103,846 .......... Income Requirement
$2,154 .......... Monthly Mortgage Payment
$477 .......... Property Tax $0 .......... Special Taxes and Levies (Mello Roos) $46 .......... Homeowners Insurance $335 .......... Homeowners Association Fees ============================================ $3,011 .......... Monthly Cash Outlays
-$353 .......... Tax Savings (% of Interest and Property Tax) -$610 .......... Equity Hidden in Payment $166 .......... Lost Income to Down Payment (net of taxes) $69 .......... Maintenance and Replacement Reserves ============================================ $2,282 .......... Monthly Cost of Ownership
Cash Acquisition Demands ------------------------------------------------------------------------------ $5,499 .......... Furnishing and Move In @1% $5,499 .......... Closing Costs @1% $4,399 ............ Interest Points @1% of Loan $109,980 .......... Down Payment ============================================ $125,377 .......... Total Cash Costs $34,900 ............ Emergency Cash Reserves ============================================ $160,277 .......... Total Savings Needed
Property Details for 16 CREEKWOOD 67 Irvine, CA 92604 ------------------------------------------------------------------------------ Beds: 3 Baths: 2 full 1 part baths Home size: 1,646 sq ft ($334 / sq ft) Lot Size: n/a Year Built: 1977 Days on Market: 15 Listing Updated: 40485 MLS Number: S636494 Property Type: Condominium, Residential Community: Woodbridge Tract: Th ------------------------------------------------------------------------------ UPGRADES GALORE!!! This gorgeous 3 bedroom townhome is located in Woodbridge, one of Irvine s premier neighborhoods. This spacious and open layout has Dual Master Suites, with a possible 3rd bedroom downstairs. The home is turnkey and ready to be lived in. There is a long list of recent upgrades which include brand new stainless steel appliances, granite countertops, distressed hardwood floors, designer paint, crown moldings and baseboards, new fixtures and much more. There is a private backyard patio, an enjoyable indoor fireplace, and an attached 2-car garage.
The neighborhood has many amenities such as beach clubs, lagoons, kayaks, sailboats, tennis courts, swimming pools/spas, banquet rooms, and many recreational parks (including children's areas) within the four square miles making Woodbridge a community of interest to anyone who enjoys outdoors and luxury. The surrounding schools are wonderful and right at your doorstop. This home is a MUST SEE!
I hope you have enjoyed this week, and thank you for reading the Irvine Housing Blog: astutely observing the Irvine home market and combating California Kool-Aid since 2006.
The current cap on the HMID is $1,000,000 for first mortgages, and $100,000 for HELOCs
Reducing the home mortgage interest deduction would certainly take much of the air out of the bubble. It would reduce loan balances, and thereby lower offers of new buyers. This will lower prices for homes in areas where loans exceed $500,000. It would immediately reduce the net worth of homeowners in those areas. However, this policy would not impact anyone else. New buyers would be taking on less debt -- which is a good thing. Renters would no longer be subsidizing the debts of homeowners through tax incentives -- which is a good thing. And tax revenues would increase -- which is why the commission is considering it.
There are only two consituencies that should oppose the changes to the HMID offered by the commission: (1) homeowners with mortgages over $500,000 -- which isn't very many people, and (2) raw land owners in the path of development -- which is very few people. Everyone else should be in favor of these changes because everyone else is sending their tax dollars to the two effected groups every year through the tax break.
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