Bloomberg News

Middle-Class Mortgage Break Tough to Curb in Debt Talks

April 05, 2013

Housing Industry Awaits U.S. Mortgage Rule on Down Payment Size

The so-called Qualified Mortgage rule issued by the CFPB requires lenders to verify borrowers’ ability to repay their loans and offers legal safe harbor for lenders who follow guidelines for safe mortgages. Photographer: Daniel Acker/Bloomberg

U.S. lawmakers are looking for ways to carve up the $70 billion-a-year home mortgage interest deduction.

What they’re finding is a political challenge that might not yield much revenue for reducing the budget deficit or lowering tax rates and may not be worth the outcry from taxpayers making between $75,000 and $200,000 a year.

A variety of ideas are being discussed to curtail the break without ending it. Options include lowering the $1 million cap on the size of deductible loans, eliminating the benefit for second homes and imposing limits on top earners’ itemized deductions, including mortgage interest.

Still, any plan that generates significant revenue would pinch the housing industry and upper-middle-class voters. Real estate agents and homebuilders are in every congressional district, and more than half the benefits of the tax break go to households earning between $75,000 and $200,000, the homeowners both parties are pledging to protect.

“It’s so woven into our economy that it’s hard to do without having economic dislocation that produces more pain than the revenue gained,” said former Representative Earl Pomeroy, a North Dakota Democrat.

In 2011, 36 million households claimed $359 billion in mortgage interest deductions, according to the Internal Revenue Service. That was down from 37 million and $387 billion the year before.

Detailed Discussions

The most detailed discussions about the deduction are happening in the House of Representatives, where the tax-writing Ways and Means Committee has broken into 11 bipartisan working groups to study ways to rewrite the U.S. tax code. The groups are wrapping up their work by April 15.

The committee plans to release and pass a bill this year. Republicans emphasize their willingness to consider anything while not yet proposing anything specific.

“I don’t think the committee knows where tax reform is headed, or how broad it will be,” Jamie Gregory, a lobbyist for the National Association of Realtors who has been invited to working group meetings, said in a phone interview. “It’s a difficult issue with a lot of moving pieces.”

Second-Home Deduction

Narrower options, such as ending the deduction for second homes, could raise about $8 billion a year. Converting the deduction into a 15 percent credit and capping indebtedness at $500,000 would yield $24 billion a year by 2019 and cause about half of households earning between $100,000 and $200,000 to pay more tax, according to the nonpartisan Tax Policy Center.

Changes limited to the top 2 percent of earners or reductions to the $1 million cap would have the biggest effect in high-cost real estate markets, such as those in California, New York and New Jersey.

Four of the 10 most expensive U.S. housing markets last year were in California, led by the San Jose metropolitan area, according to the National Association of Realtors.

What’s important is how the deduction fits in a tax plan designed to lower rates and promote U.S. economic growth, said Representative Diane Black, a Tennessee Republican on Ways and Means who said the second-home deduction is under scrutiny.

“The best thing for folks to get to be able to afford a house is a job and higher wages,” she said.

1986 Survivor

The mortgage interest deduction is a long-standing feature of the tax code and a survivor of the 1986 rewrite that prohibited taxpayers from deducting credit-card interest.

It’s available only to the one-third of U.S. taxpayers who itemize their deductions, and that means it disproportionately benefits higher-income earners with higher marginal tax rates.

The tax break’s defenders warn that scaling it back could discourage homeownership, causing home prices to drop with ripple effects in the construction, furniture and appliance industries whose fortunes rise and fall with the housing market.

David Stevens, president and chief executive officer of the Mortgage Bankers Association in Washington, said his group would consider changes to the deduction as part of a broad-based deficit-cutting plan as long as policy makers carefully analyze the potential effects.

Values Rebound

Last year, median home values across the country continued to rebound, rising 6.4 percent to $176,900, according to the National Association of Realtors. The nation’s most expensive markets included the metropolitan areas of San Jose, San Francisco, San Diego, Los Angeles, New York, Boston, Washington, Seattle and Denver, the Realtors group said.

Limiting the mortgage deduction “is a lot more likely now than before” the financial crisis, especially with lawmakers’ focus on deficit reduction, said Greg Reiter, head of residential mortgage research at Wells Fargo & Co. (WFC:US), the biggest U.S. home lender with about one in three residential mortgage originations.

“It would effectively raise a borrower’s monthly payment and lower house prices,” Reiter said in a phone interview. “It would be smart to do it gradually, so we don’t kill the whole thing.”

Reducing the $1 million cap would have relatively little effect on taxpayers because loans that large are rare, said Stevens, former commissioner of the Federal Housing Administration. Many homeowners in that category have other assets they could use to pay off the portion of their mortgage that would exceed a lower cap.

‘Emotional Win’

“That becomes more of an emotional win for those that want to take it out of the wealthy, per se,” he said. “You’re not going to get a significant pick-up in tax revenues as a result.”

Reducing the cap to $500,000 would affect fewer than 10 percent of mortgages, some of which include vacation home debt in a single mortgage, said Todd Sinai, associate professor of real estate and business economics and public policy at the University of Pennsylvania’s Wharton School.

“The reason to lower the mortgage cap from $1 million to $500,000 is really to not index it for inflation and have it be more binding in the future,” he said.

To contact the reporters on this story: Richard Rubin in Washington at rrubin12@bloomberg.net; Dan Levy in San Francisco at dlevy13@bloomberg.net

To contact the editor responsible for this story: Jodi Schneider at jschneider50@bloomberg.net


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