The new tax plan has been framed as a deathblow to the American dream by some real estate professionals and groups, who warn of falling home prices, a new generation trapped in renting, and an exodus of residents from the highest-cost cities and states.
But are these fears surrounding the new, lower cap on mortgage interest deduction—and the incentive for taxpayers not to use it—overblown? Or are there indeed big repercussions to come? That all depends on whom you ask—and where they live.
The Republican tax plan allows taxpayers to deduct mortgage interest on loans up to only $750,0000 combined for both primary and secondary (vacation) homes. The previous limit was $1 million.
The U.S. House of Representatives passed the plan on Tuesday, but will need to hold a revote, likely on Wednesday. Several provisions appear to be in violation of U.S. Senate rules. The Senate was slated to vote on the proposal on Tuesday as well, and President Donald Trump is expected to sign it into law before the end of the year.
The vast majority of new homeowners won’t be affected, as the median home price is nowhere near $750,0000. The median list price is $270,000 nationally, according to realtor.com® data.
Existing homeowners will be grandfathered into the previous deduction limit. So the new cut is expected to affect only about 1.3% of new mortgages, according to realtor.com data. These are likely to be awarded to the wealthiest homeowners, who can at least theoretically afford the cuts, and those living in the most expensive parts of the country.
What’s more worrisome is that fewer homeowners are likely to take the mortgage deduction. That’s because the new tax code will double the standard deduction, to $12,000 for individual filers and $24,000 for married couples filing jointly, and eliminate many of the other available deductions for taxpayers. So there’s less of an incentive to itemize.
“On a scale of 1 to 10 on if interest deductibility is going to have a big impact on housing, it’s a 2,” says Ken Johnson, a real estate economist at Florida Atlantic University in Boca Raton. “It’s not clear that it will hurt housing. But it is clear that it’s not going to help.”
That’s because most taxpayers don’t itemize their tax bills anyway, so they aren’t taking advantage of the available deductions. Only about a third itemize, and 21.5% claim the mortgage interest deduction. The mortgage deduction netted them an average $8,612 write-off in 2015, according to the Pew Charitable Trusts.
“When you take the standard deduction, you’ve lost that subsidized benefit of homeownership,” Johnson says.
Fewer homeowners taking the deduction may be a good thing after all
Losing the mortgage write-off isn’t necessarily a bad thing. Some housing experts have described it as wasteful and blamed it for inflating housing prices and encouraging buyers to borrow more money for bigger houses, according to the New York Times.
“My basic view is if you subsidize something you’ll get more of it,” Edward Pinto, co-director of the conservative American Enterprise Institute’s Center for Housing Markets and Finance, told the Times. “And as a country we’ve been subsidizing debt.”
The mortgage interest deduction was created in 1913. It was a byproduct of Congress making interest deductible when it passed the first income tax.
“It feels problematic to be using the tax code to support people buying houses that are this expensive or, even worse, to be encouraging housing prices to rise further,” Harvard economist Edward Glaeser told the Times.
So who will mourn the changes to the deduction?
Residents of cities and states where housing costs and taxes are sky-high are likely to be hardest hit by the changes to the tax code. Those hailing from Washington, DC; California; Hawaii; Massachusetts; and New York will be the most affected, according to realtor.com data. These states have the highest percentages of mortgages worth $750,000 and up.
“At a national level, it’s not likely to affect very many people,” says Joseph Kirchner, senior economist at realtor.com.
However, he adds, ”in certain high-housing-cost markets, it is still a concern because there will be significant numbers of people who’ll be impacted.”
Those folks could lose out on several thousand dollars a year in tax refunds, says Patrick Carlisle, chief market analyst at the Paragon Real Estate Group, based in San Francisco.
“In an area like ours, where our median house price is $1.5 million, it’s not a huge [decider] in someone making a decision to buy a home. Even the previous limit was well below what many buyers in San Francisco” were spending, he says. “It’s property taxes and state income taxes that are going to have a grievous effect on residents in states like California, New Jersey, and New York.”
That’s because residents will be able to write off only up to $10,000 in property and either income or sales taxes. So the property tax bill on that $1.5 million abode is likely to be more than $15,000. When folks can no longer deduct their income tax as well, it means that owners’ bank accounts are likely to take a big hit.
“Everything combined is where the whammy” comes in, says Carlisle. He fears more people will leave and fewer will come into the San Francisco Bay Area, where residents may make more but also spend more due to expensive housing and overall cost of living. “It certainly doesn’t incentivize someone to live in the Bay Area or a buy a home in the Bay Area.”
Will these changes dissuade buyers from becoming homeowners?
Whether or not they can deduct the mortgage interest is not likely to dissuade too many people from buying. Homeownership is the American dream, after all. Conventional wisdom says it’s an opportunity for the middle class to build equity and wealth over time. Plus, many folks don’t like the idea of forking over their hard-earned cash on rent or not being able to modify their abodes as they wish.
But the changes could dissuade some buyers on the margins to continue renting. That’s because when these more cash-strapped folks do the math, they won’t be saving nearly as much by owning the roof over their heads.
This could lead to housing prices to fall. Or, if more prospective buyers suddenly see more money in their paychecks thanks to the tax cuts, they could enter the market. And that could push prices up.
“I just don’t see [the mortgage interest deduction] as as big of a deal as everybody is concerned about,” Johnson says. “Most people have already stopped using the deduction.”