At last, we come to the final part of this seemingly never-ending series. I’ll finally get to what I think is the best way to get ourselves out of the fiscal mess that the MID has created in the fairest way possible.
After a bit of a hiatus, we’ll come back now to the main line of argument against the MID. In this part, I’ll tackle, or at least address, a broader issue: Should the government be in the business of promoting home ownership in the first place?
The Mortgage Professor (don’t let the hideous, 90s-style formatting fool you, this site is actually quite good!) makes an interesting point that I hadn’t thought of: As long as mortgage interest is tax deductible, so should mortgage insurance and title insurance premiums.
Interest payments on home mortgages are deductible, and no distinction is made by IRS between the portion of the interest payment that represents compensation for the time value of money, and the portion that represents compensation for risk. If a low-risk borrower pays 7%, for example, while a high-risk borrower- pays 9%, the entire interest payment of the high-risk borrower is deductible. However, if the lender charges both borrowers 7% but requires that the high-risk borrower purchase mortgage insurance, with the mortgage insurer now collecting the 2% or its equivalent, IRS will not allow the 2% to be deducted. That is inconsistent.
Yep, spot on. On title insurance:
Title insurance premiums on a policy that protects the lender only also should be deductible, but aren’t. The same is true of expenses billed to the borrower that are incurred by a lender in connection with a loan, such as a credit check or appraisal. IRS says they are not deductible because the borrower receives a service for them, but this is a fiction. The lender requires these services as condition for granting the loan, and they provide little or nothing of value to the borrower beyond the loan itself. Furthermore, if the lender elects to cover these expenses in the interest rate or points, they are fully deductible.
That last sentence, especially, is very insightful. I remember that my mortgage lender offered to waive all lender fees in exchange for a higher interest rate on my loan. It worked out to be a terrible deal for me (pay ~$20 / month more to save $800 upfront), so I elected not to, but I hadn’t thought about how those 2 different ways of paying lender fees had different tax implications. The extra $20 / month would have been 100% deductible, while the $800 I chose to pay upfront was not deductible at all.
When I think about all the different mortgage loan choices that are available, I’m reminded of a Carmax commercial from several years ago, where a man held up a balloon and said that other dealers might give you a lower price, but they’ll “squeeze” you and make up for it some other way: They’ll charge you a higher rate on your loan, or give you less for your trade-in, or put in some other junk fee to make up the difference. I think mortgages are very similar in the way that some loans give you a lower rate but more points, or fewer points but higher lender fees, or lower fees but a higher rate. It seems to me that lenders treat these as interchangeable ways to charge you the real cost of the loan (and possibly as a way to confuse the consumer with the wide array of choices.) I think the professor makes a great point that the IRS’s distinction between points/interest payments and lender fees makes for an inconsistent tax policy.
I’ll take a break from the longer posts about the MID to do a gentle introduction to what I referred to in my introductory post as technical education. We’ll start off with something easy so I don’t scare away any reader(s) I may have left.
Just today I was looking over the Case Shiller index numbers for October (they’re released after a 2-month lag, so this is the most recent data available). The numbers, as released by S&P, are just index values, listed separately for 20 cities along with 10- and 20-city composite values. I always put these raw values into a spreadsheet I’ve made that does some simple calculations on them. For each city, I look at the month-to-month change (October’s index value compared to September’s), the year-over-year change (October’s index compared to last October’s index), and the percentage change from both the peak and the post-bubble trough.
This time, I happened to notice something about San Francisco’s values:
- From peak to trough, SF’s index declined 46%.
- From that trough, the index has gone up 12% as of this month.
- From the peak to now, though, the index has declined 39%.
So, doing addition doesn’t work here. A 46% drop followed by a 12% gain doesn’t give you a drop of 46% – 12%. The reason, of course, is that the two percentages are computed from a different baseline: the 46% means 46% of the (much higher) peak index value, while the 12% is calculated from the (much smaller) trough value.
This isn’t rocket science, but it’s easy enough to forget when you read articles describing housing prices, along with what some might call their recent recovery (though the recovery hasn’t been particularly strong.) There’s a natural tendency to compare numbers when they’re presented next to each other, as percentages like this often are in the press. You might think that, since the index has increased 12%, that it’s about a quarter of the way back to its bubble-level highs after the 46% drop. But that’s not the case: the index will have to increase a total of 86% from its lowest point to get back to its record high. That’s still a very long way to go!
Now that the softball arguments are out of the way, it’s time to tackle what I consider the one real argument for the MID that might have a wee bit of merit. As our good old friend Lawrence Yun puts it:
One thing that is indisputable is that eliminating the mortgage interest deduction will lower the home ownership rate in the U.S.,” he said. “While we must ensure that the conditions that led to the artificially inflated home ownership rate of the bubble years do not resurface, we also need to create the conditions for sustainable home ownership, which has been shown to provide myriad social benefits for families and communities.
Hold on to your hats, folks, because I’m about to do the impossible, and dispute the indisputable! In fact, I disagree with his premise, both in a more theoretical sense and from a practical, empirical perspective. For now, I’ll just look at whether the MID actually does increase the home ownership rate, and later on in the series I’ll come back to whether the government should care about the home ownership rate at all.
(Part 2 of 5: See part 1 for historical background)
We finally arrive at the heart of the matter: Is the MID actually a good idea? In this part, we’ll look at the (honestly, pretty silly) arguments for it, straight from the NAR. Remember folks, these are the people who are lobbying, and very likely influencing, your Congressmen. Without further ado, I’ll go through them, one by one, as presented here:
(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. Continue reading