(Part 1 of what I believe might turn into a mammoth 5-part post. We’ll see.)
The mortgage interest deduction (MID) is silly. It doesn’t promote home ownership, it doesn’t benefit the middle class (actually, I’d go further and say it doesn’t really benefit any homeowners at all), and it amounts to a giveaway to the real estate industry while simultaneously contributing more to America’s debt than any other single cause I can think of, unless you lump all wars into one category. And yet, due largely to historical accident, it’s become quite entrenched in the US tax code, and a fair argument can be made that getting rid of it now would cause substantial economic harm. In an ideal world, I think such a policy never would have existed, but given the current economic situation, I would advocate for a slower phase-out of the deduction, which I’ll detail later.
Perhaps optimistically, I’ll wager that I may at some point have at least one reader who is unfamiliar with this deduction, so I’ll start out by giving a very simplified summary of what it does. If you buy a home and take out a mortgage to pay for some or all of it, all your interest payments on the mortgage loan are deductible from your federal income taxes, up to $1M, as long as the loan is for either your primary residence or second home. So, just to point out a few basic facts.
- The value of the deduction depends on the amount of interest you pay (which itself is dictated by the amount of the loan, the interest rate, and the term), as well as your marginal tax brackets. In raw dollar terms, the higher your tax rate, and the higher your loan amount, and the higher the interest rate you pay, the larger your savings from the deduction will be. (Of course though, you don’t want to pay more interest just for the tax savings; that’d be spending a dollar to save a quarter. But the fact remains that the deduction is higher for higher-interest loans.)
- The deduction only applies if you itemize. If the value of all your itemized deductions, including mortgage interest, is less than the value of the standard deduction (currently $5,800), then it’s not worth it to claim the MID.
- The amount of savings you get will typically decrease over time: later in the term of a mortgage loan, more of your payment is going towards principal, and less toward interest.
First things first, though: How did it come about? Without going too far afield into the history of the US tax system, all interest expenses used to be deductible (see, for example, Wikipedia’s summary.) I haven’t been able to find a detailed source for the motivations for this, but the basic underlying reason was that the majority of loans at the time were business loans, for which an interest deduction makes sense, as it is a type of business expense. The majority of personal loans that we have today, and mortgages in particular, simply didn’t exist at the time this part of the tax code was written. Coupled with the fact that bookkeeping wasn’t what it is today, and the difficulty of untangling business loans from the few personal loans that did exist, the idea of making all interest deductible may well have been reasonable at the time. As new types of loans became more popular, they fell under this general interest deduction rule due to the way it was written. And so it went on for many years: All interest, including student loan interest and even credit card interest (!), remained deductible until the passage of the Tax Reform Act of 1986. The Tax Reform Act eliminated the deductions for most types of interest on personal loans, but it specifically allowed for mortgage interest to continue to be deducted.
(According to this article, Reagan told the National Association of Realtors: “I strongly agreed with the home mortgage interest deduction, which is so vital to millions of hard-working Americans. And in case there’s still any doubt, I want you to know we will preserve that part of the American dream,” he said. “Well, that is the thing, that deduction, that symbolizes, I think, that American dream.” Wow, no wonder they called him the Great Communicator! I’m tearing up just thinking about that sacred American Dream.)
So, for better or worse, whether or not Congress ever actually intended it, people have been deducting interest on their mortgages from their taxes for as long as mortgages have been commonplace. This naturally brings us to the question: Is this a good thing? I think the answer is quite emphatically no.
Predictably enough though, there are many who don’t agree with me. For one, public opinion is strongly in favor of the deduction. Depending on who you believe, somewhere around 90% of the public supports the MID. Lucky for me, I’ve never been one to cave in and believe something just because it’s popular to do so. I think this support stems largely from a self-serving desire to pay lower taxes, regardless of long-term cost or whether it really makes sense as a policy, and widespread misconceptions about what the deduction actually accomplishes. And as you might have guessed, the National Association of Realtors emphatically opposes any change to the deduction. In fact, I’ve even seen it mentioned on the NAR website that “even talking” about changing the MID can affect home values. Yikes! I hadn’t even considered the notion that I might be lowering everyone’s home values just by writing this, but I’ll take the risk.
To avoid an excessively long post, I’ll end part 1 here. In part 2, I’ll examine some of the more superficial, sound-bite type arguments made in support of the MID, mostly straight from the mouth of the NAR. Part 3 will look at some of the more thoughtful arguments that I think can be made. In part 4, I’ll examine what I consider to be separate arguments for why we should not have the deduction, beyond a lack of any meritorious argument for why we should have it. In part 5, I’ll deal more practically with what I think we should do in the current situation. In particular, I’ll discuss why I don’t think it would be wise to do away with it entirely and immediately, and what I consider a more realistic (and, dare I say it, possibly even politically viable… maybe) alternative.