The Reduction of the Mortgage Tax Deduction

** UPDATED BELOW

The uproar over the proposed reduction of the mortgage-interest income-tax deduction continues to rumble along, and I have to say I'm surprised. I thought this thing would have disappeared by now, but there it is, in an election year.

Today, there's an interesting column by Carl Ingram in The Desert Sun, a newspaper in Palm Springs. Ingram is identified at the end of the piece as being a Realtor at Keller Williams Realty in Rancho Mirage.

Among the points he makes is this startling statement of fact: For the first time in three years, Southern California has experienced a year-over-year increase in foreclosure activity - a whopping 19.9 percent. And because of exotic loans, escalating interest rates and lackluster property appreciation rates, experts predict the foreclosure rate could double by the end of 2006.

Indeed, this is the reverse of what happened during the run-up of the boom. By 2002, evictions had all but dropped off the radar in Southern California. This was due to a combination of things, not the least of which was the ability to borrow your way out of debt easily, to put off the inevitable by simply borrowing more. Now, here comes the reality — the banks actually want to be paid back under the terms agreed to by borrowers. It will be interesting to follow this mortgage deduction issue in the coming months.

Here's an excerpt:

This autumn, the president convened a tax advisory board, who under the auspices of devising simpler and fairer tax laws, were poised to further damage the housing market by suggesting a reduction of the mortgage-interest deduction. The ill-conceived tax proposal could rival the devastation resulting from a large-magnitude earthquake in our valley.

The proposal is a subliminal tax increase levied on the backs of the middle-class homeowner disguised as a fair reapportionment of tax liabilities. Surely this decision would purge investments from the real-estate market and channel them into the stock market; an act that would mimic previous (failed) efforts by President Bush (with Alan Greenspan's approval) to divert funds from Social Security accounts into the stock market.

The mortgage-interest deduction is one of the simplest tax codes, and has proven to be an extremely valuable incentive for achieving and expanding homeownership. Current law permits deductions of interest paid on mortgages of up to $1 million on a primary residence, and one additional residence. Also, deductions may be utilized for interest paid on home-equity loans of up to $100,000.

The president's advisory board has suggested reductions in deductions of interest on property, which if enacted today would only range from $227,000 to $412,000. Furthermore, mortgages on second homes and interest paid on home-equity loans would become ineligible.

Crash landing

Surely, our government has noticed evidence of a significant cooling trend in the real estate market, and I know they understand how important the housing industry is to maintaining a healthy economy.
But I am bewildered as to why they fail to understand that the results of the advisory board's actions and continued interest-rate hikes could spell the difference between a soft landing and an earth-shattering burst in the housing bubble.

Some industry experts predict that nationally a bubble burst could mean the loss of from 5 million to 6.3 million jobs, and could thrust our nation into a severe recession. For the first time in three years, Southern California has experienced a year-over-year increase in foreclosure activity - a whopping 19.9 percent. And because of exotic loans, escalating interest rates and lackluster property appreciation rates, experts predict the foreclosure rate could double by the end of 2006.

In our valley paradise, the damage would be most notable in the central and western areas . That's because out-of-state buyers and buyers from coastal communities, who are primarily responsible maintaining local property appreciation, would lose the incentive to purchase property in that price range, and many homeowners would lower their property values to figures within the range of the cap reduction.

Coachella Valley real estate activity could change dramatically. Condo sales would show some improvement, but a lion's share of the sales activity would be diverted into areas that exhibit the cheapest dirt, such as in Desert Hot Springs, Thousand Palms, and portions of Cathedral City and Indio.

Find the rest of this commentary at this link.

** UPDATE

An interesting list of reasons to support a reduction in the mortgage deduction was offered by readerPeterBob:

1. It is highly regressive, with most of the tax breaks going to people with high incomes who live in expensive homes. Many low income homeowners don't benefit from it. Homeowners are much wealthier than renters, so why should they receive a subsidy?

2. The tax break does NOT do a lot to increase homeownership. A better bet would be a direct tax break to low income people for a downpayment.

3. The tax break encourages large homes to be built.

4. The tax break encourages people to use home equity loans instead of credit cards, for everything from vacations to car loans. Again, why should homeowners, who are wealthier than renters, get a tax break to borrow?

— The Boy in the Big Housing Bubble