home ownershipOne of the most critical programs facilitating the rise from poverty, and contributing to increased wealth for the middle class is at risk of becoming eliminated to no one’s benefit. The issue is the home mortgage interest deduction (HMID).

A recent article published by the National Priorities Project, “Should We Reform the Home Mortgage Interest Deduction? Three Different Views from Our Readers,” addresses the issue, as the title indicates, through the opinion of three readers. The opinion of Doris from Fort Washington, MD, is a personal expression of the benefit she receives through it, which fits in nicely in contrast to the criticism of the viewpoint expressed by Jonathan from Escondido, CA:

that the big beneficiaries of the home loan interest deduction are the banks.” The HMID makes homes more affordable “without lowering the price tag of the house (and therefore the amount of the loan) … and therefore pushes the price up.” After doing tax savings calculations with clients for many years, he felt that “if there were no home loan interest deduction, the price of real estate would be lower.” So, he concluded, “the deduction does not really benefit the working class.

The opinion expressed therein by Jonathan misses the point—and I suspect he’s an idiot wing-nut. It’s basic economic principle. Demand causes prices to go up, and the HMID helps encourage home ownership. But home ownership is also the basis of wealth creation for the middle class, because the demand causes appreciation in the value of their home.

If the tax break were the sole motivation for ownership, the viewpoint that it drives up prices might have more than a miniscule claim to validity. There are many more though, including pride of ownership, freedom of expression—and a home’s value as an investment among others. As an investment, a home purchase allows a buyer to put as little as 3.5% down on an Federal Housing Administration (FHA) insured loan, and earn appreciation against the whole value of a home—which can be equivalent to over 20% interest when homes appreciate by as little as 3% per year.

leveraged investmentIn this, a home is among the few leveraged investments available to middle income earners—and the only one available to low income earners. But there’s another factor. Since the ’90s, most home owners no longer pay capital gains tax on the sale of a home up to a certain value. Between this and the home interest deduction, the principal benefits of this exemption accrue to lower and middle income earners.

By the way, in most locations, mortgage payments are also lower than rental payments, which brings this issue to another financial benefit accruing to home owners. Not only do they pay less to live per month, but they get the lion’s share of that payment in a tax break over the first 20 years of a 30 year note.

Now, you might argue that the monthly mortgage payments are an ongoing outlay to earn that “interest,” but you would be missing the point that it is more than offset by the monthly rent not paid. Then there’s the cost of maintenance on the home. Sorry, but the average one to four percent of value it costs to maintain a home just does not amount to a significant offset to it’s value as an investment.

The opinion expressed by Robert, from Milwaukee, WI, is just sour-grapes, but does point out a reasonable reform:

that the big beneficiaries of the home loan interest deduction are the banks.” The HMID makes homes more affordable “without lowering the price tag of the house (and therefore the amount of the loan) … and therefore pushes the price up.” After doing tax savings calculations with clients for many years, he felt that “if there were no home loan interest deduction, the price of real estate would be lower.” So, he concluded, “the deduction does not really benefit the working class.

Relative to income, the wealthy garner far less benefit from the HMID than lower income individuals. They are however also among the few who can afford a second home—and those in the upper middle class who can afford a second home do not need the deduction to live well. On the other hand, middle and lower income individuals most often plan purchases of consumer goods around their tax returns, which stimulates the economy.

If anything is done to “reform” taxes that included alteration of the home interest deduction, it should involve only elimination of the second home from eligibility, and a cap on the interest paid on the first mortgage. Anything else would shift the burden of taxation onto the backs middle and lower income earners, and result in a contraction of something our economy sorely needs—demand.

Advertisements