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Is the Mortgage Interest Deduction Doomed?


While eliminating the MID may sound like a popular, hard-line approach to expensive government subsidies for the housing market, the reality is it's not going anywhere anytime soon.

It doesn't make nearly the headline fodder as revolution in Egypt (or Wisconsin), but the fate of the mortgage interest deduction, or MID, is a hot topic in housing finance circles this budget season. And while eliminating the MID may sound like a popular, hard-line approach to expensive government subsidies for the housing market, the stark reality is that the MID is not going anywhere anytime soon.

The new Obama administration budget calls for stemming the benefit homeowners get by writing off interest on mortgages. Specifically, the president wants to limit deductions for homeowners earning more than $250,000 in annual income. Meanwhile, deductions on up to $1 million in mortgage debt, loans on second and third homes, and home equity lines of credit would remain in place. The MID isn't the budget's largest line-item, but it is no small potatoes, either.

Estimates vary, but the consensus is that the MID is around a $100 billion per year budget item. However, only one-third of homeowners actually get to take the deduction because many homeowners don't itemize their deductions, missing out on one of the highly touted tax benefits of owning a home.

Lining up to defend the MID are powerful real estate and mortgage special interest groups, eager to promote home ownership (and of course member commissions). They argue that at a time when the housing market is already so shaky, removing this incentive to own real estate would undermine the feeble recovery that already appears to be faltering. Unsurprisingly, the National Association of Realtors, or NAR, the powerful real estate lobbyist group, is up in arms: "NAR opposes any changes that would limit or undermine current law."

On the other side are a smattering of economists who aren't sure the MID has much of an effect anyway. And if it does, the tax savings could be put to much better use. In a recent Financial Times piece, Robert Pozen pointed out that in Australia, Canada, and England, countries with similar demographics and legal structures to the United States, there is no MID yet home ownership rates remain higher than ours (which currently stands at its lowest in more than a dozen years).

Others believe that the MID and other subsidies via Fannie Mae and Freddie Mac -- in addition to accommodating interest rate policy that has helped boost mortgage-lending profits at money center banks Wells Fargo (WFC), JPMorgan Chase (JPM), Citibank (C) and Bank of America (BAC) -- allocate too many precious public dollars to housing. Far better to invest in innovation, or pretty much anything that can't be boiled down to four walls and a roof.

Ultimately -- and unfortunately because much of the discussion over US housing policy falls into this same category -- the debate is futile in the near future. The MID in its current form reduces the cost of a home by about 20%. If this sounds astounding, do the math. The mortgage payment for a buyer putting down 20% to buy a $300,000 home and taking out a 5.0% mortgage is $1,288. The buyer gets to write off the $12,000 in annual interest paid, reducing his or her taxes by $3,000 assuming a 25% tax bracket. That's $250 per month, making the buyer's effective monthly mortgage payment just over $1,000 per month. The equivalent monthly payment pencils out to a home that costs around $240,000, or 20% below the original $300,000.

Current government policy states an explicit desire to prop up home prices, so expecting a policy that would almost immediately give property values a 20% haircut is untenable, at best. Even the current proposal will have a hard time surviving; a similar one last year got shot down by a Democrat-controlled Congress. Far better to focus near-term efforts on resolving the Fannie Mae and Freddie Mac debacle, as the only way the housing market can truly heal is with a functioning, liquid, private secondary market. As long as the zombie-like Fannie and Freddie are allowed to hang around, housing will remain in a painful limbo.

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