The Pros and Cons of the Mortgage Interest Deduction

Lawmakers contest that doing away with the deduction could save the country millions each year.

May 4, 2014 at 10:21AM
Diamond

John W. Diamond, Ph.D.
Adjunct Professor of Economics at Rice University

Perhaps the most highly debated "benefit" to owning a home is the mortgage interest deduction. Deficit-fighting lawmakers contest that doing away with the deduction could save the country millions each year. Advocates say it's essential to promoting homeownership. Some say it only benefits the rich.

According to a recent survey from HSH.com, 55 percent of homeowners said the mortgage interest deduction was important. Interestingly enough, over 28 percent said they "weren't sure" if the deduction was an important financial incentive or not.

To learn more about the mortgage interest deduction and its place within the U.S. real estate market, we interviewed Dr. John Diamond, adjunct professor of economics at Rice University.

Q: There has been talk of doing away with the mortgage interest deduction. Could you discuss the pros and cons of this deduction?

A: The most common criticisms of the mortgage interest deduction (MID) are that:

  • It does not achieve its main goal of increasing homeownership
  • It is a tax break for the well-to-do

The MID is not structured properly to achieve the goal of increased homeownership for two reasons:

  1. The deduction is only allowed for those that itemize deductions (primarily higher income taxpayers)
  2. The value of the deduction increases with the individual's income tax rate so that higher income taxpayers receive more benefit than lower- and middle-income taxpayers

Thus, in its current state, the MID is more likely to encourage prospective homeowners to buy larger houses rather than to encourage significant homeownership at low- and middle-income levels.

Proponents of the MID argue that subsidizing homeownership is related to positive external benefits and thus homeownership should be subsidized.

Q: Do you think Congress should do away with this deduction, or perhaps alter it?

A: The deduction should be altered by reducing the cap on the amount of mortgage principal on which interest receives a tax preference, coupled with either:

  • Deductibility of only a fraction of home mortgage interest; or
  • A fixed-rate non-refundable tax credit for home mortgage interest

If deemed necessary to allow time for further recovery of the housing market, these provisions could be enacted with a delayed effective date.

Q: How would an altered MI deduction impact homebuying?

A: Dr. George Zodrow and I produced some simulation results on the effects of either eliminating or curtailing the MID (http://bakerinstitute.org/research/the-dynamic-effects-of-eliminating-or-curtailing-the-home-mortgage-interest-deduction).

The most dramatic reform was the complete elimination of the MID. When the MID was eliminated:

GDP: GDP decreases slightly in the short run due to the adjustment costs incurred in reallocating the capital stock, and increases slightly by 0.1 percent in the long run.

Investments: Overall investments increase by less than 1 percent, reflecting the expected reform-induced increases in investment in the non-housing sectors and the rental-housing sectors, coupled with a decrease in investment in the owner-occupied-housing sector of about 6 percent initially and 3 percent in the long run.

Asset values: Asset values increase in the non-housing sectors by less than 2 percent and by 3.5 percent in the rental-housing sector, coupled with a decline in the value of owner-occupied housing of roughly 4 percent.

Replacing the MID with a credit
The effect of replacing the MID with a 12 percent non-refundable credit subject to a $25,000 interest cap and limiting the MID to primary residences is qualitatively similar but significantly smaller. For example, for the capped credit, housing investment in the owner-occupied sector declines initially by 2.6 percent and by 1.5 percent in the long run, and the value of owner-occupied housing declines by roughly 2 percent.

This article The Pros and Cons of the Mortgage Interest Deduction originally appeared on HSH.com.

Take advantage of this little-known tax "loophole" today
Recent tax increases have affected nearly every American taxpayer. But with the right planning, you can take steps to take control of your taxes and potentially even lower your tax bill. In our brand-new special report "The IRS Is Daring You to Make This Investment Now!," you'll learn about the simple strategy to take advantage of a little-known IRS rule. Don't miss out on advice that could help you cut taxes for decades to come. Click here to learn more.

You may also enjoy these housing articles:

How much of will your mortgage cost over the life of your loan?

What are the current mortgage rates?

Homebuyer timeline: Step-by-step guide to purchase a home

Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Money to your ears - A great FREE investing resource for you

The best way to get your regular dose of market and money insights is our suite of free podcasts ... what we like to think of as “binge-worthy finance.”

Feb 1, 2016 at 5:03PM

Whether we're in the midst of earnings season or riding out the market's lulls, you want to know the best strategies for your money.

And you'll want to go beyond the hype of screaming TV personalities, fear-mongering ads, and "analysis" from people who might have your email address ... but no track record of success.

In short, you want a voice of reason you can count on.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich," rated The Motley Fool as the #1 place online to get smarter about investing.

And one of the easiest, most enjoyable, most valuable ways to get your regular dose of market and money insights is our suite of free podcasts ... what we like to think of as "binge-worthy finance."

Whether you make it part of your daily commute or you save up and listen to a handful of episodes for your 50-mile bike rides or long soaks in a bubble bath (or both!), the podcasts make sense of your money.

And unlike so many who want to make the subjects of personal finance and investing complicated and scary, our podcasts are clear, insightful, and (yes, it's true) fun.

Our free suite of podcasts

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. The show is also heard weekly on dozens of radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable. Rule Breaker Investing and Answers are timeless, so it's worth going back to and listening from the very start; the other three are focused more on today's events, so listen to the most recent first.

All are available for free at www.fool.com/podcasts.

If you're looking for a friendly voice ... with great advice on how to make the most of your money ... from a business with a lengthy track record of success ... in clear, compelling language ... I encourage you to give a listen to our free podcasts.

Head to www.fool.com/podcasts, give them a spin, and you can subscribe there (at iTunes, Stitcher, or our other partners) if you want to receive them regularly.

It's money to your ears.

 


Compare Brokers