There are two good ideas that have been circulating recently that would help keep the housing market from experiencing another dangerous bubble:
- End (or greatly scale back) the mortgage interest tax deduction.
- Require at least a 20% down payment for purchases.
Here’s a recent article that covers the arguments in favor of ending the deduction: Mortgage-interest tax break in spotlight
Ending tax breaks for oil, corporate jets and hedge-fund managers is nearly every Democrat’s favorite way to reduce the federal debt.
But one of the biggest tax breaks is the mortgage-interest deduction, and its benefits are heavily concentrated in a handful of pricey cities, none of which votes Republican.
As Congress’ new deficit-reduction committee sets about finding up to $1.5 trillion to trim by Thanksgiving, tax breaks of all kinds, including the interest deduction, are getting new scrutiny. Beloved by the public and the real-estate industry, the deduction will cost the government more than $1 trillion over the next decade.
But few homeowners know how skewed it is by region and by income.
Three metro areas — New York, Los Angeles and San Francisco — receive more than 75 percent of the subsidy, according to a 2004 study by economists Todd Sinai and Joseph Gyourko.
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The bigger the mortgage, and the higher one’s income, the bigger the deduction. A person in the top tax bracket of 35 percent who borrows $1 million can receive a tax break of $17,500. That’s on top of a slew of other subsidies, such as preferential capital-gains taxes on the sale of a primary residence, deduction of local and state property taxes, and subsidies to mortgage giants Fannie Mae and Freddie Mac.By comparison, those earning less than $75,000 receive less than $200 in savings from the deduction. More than three-fourths of taxpayers do not itemize and so don’t claim the deduction. Those who rent or have paid off their mortgages, most of them seniors, get none.
The chief recipients are younger, well-off households that receive “a big incentive to increase the size of their mortgage or house,” said Eric Toder, co-director of the Tax Policy Center, a joint research group of the Urban Institute and Brookings Institution.
The deduction’s value increases with the cost of a home, suiting pricey real-estate markets such as San Francisco and Manhattan, or hot vacation spots such as Aspen, Colo.
I’m sure you can guess where most real estate salespeople fall in this debate. Here’s a recent piece from the NAR that lays out their position: What We’re Fighting For
“We’re at a turning point,” said Phipps, “not just because our livelihood is at stake, but because home ownership in an absolute sense is at stake. The privileges we’ve had, our parents had, and our grandparents had since World War II are being eroded, and our children face having [those privileges] denied to them.”
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The public policies that enshrine home ownership as part of the American dream, including the mortgage interest deduction and readily available 30-year financing, can’t be counted on unless the nation’s citizens become engaged in the political process.
Wow, that is some thick rhetoric. Nothing like appealing to emotions when you can’t make a rational argument for your position.
The other good idea, requiring 20% down payments from most buyers just makes sense: Don’t buy stuff you cannot afford, right?
From the Wall Street Journal: Regulators Push 20% Down Payments on Homes
Banking regulators are pushing for mortgage-lending rules that require homeowners to make minimum 20% down payments on loans classified as lower-risk, according to people familiar with the matter.
The proposal is being floated as a way to rewrite the rules for mortgage lending to prevent a rerun of the housing bubble and financial crisis that resulted from years of easy credit. The Dodd-Frank financial overhaul law enacted last year enabled regulators to define a so-called gold-standard residential mortgage that would be exempt from costly new rules.
At least three agencies—the Federal Reserve, the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency—back a proposal to require home buyers to put down at least 20% of the sales price in order to obtain one of these “qualified residential mortgages.” One proposal would also require borrowers to maintain a 75% loan-to-value ratio for refinances, and a 70% loan-to-value for cash-out refinances in which the borrower refinances into a larger loan, according to people familiar with the matter.
To hear real estate salespeople tell it, requiring 20% down would be Armageddon for the housing market. From the same REALTOR link above: What We’re Fighting For
[Buyers] hear regulators talking about the need for skin in the game, so they think QRM is great. But when they hear a minimum 20 percent down payment would be required, they say, ‘That’s ridiculous.’ None of them have 20 percent to put down.”
Efforts to limit or eliminate the mortgage interest deduction, do away with the government-sponsored secondary mortgage market, or require 20 percent down for an affordable mortgage are just a few of the ways the financial crisis and today’s federal budget debate are upending the generations-old consensus in Washington about the central place of home ownership in the United States.
I especially enjoyed the headline and some of the quotes this article that popped up in my inbox last week: Get ready to rent: If home buying rules change, more than half can’t afford it
Future homebuyers could have to make a down payment of 20 percent under new rules proposed to prevent another financial meltdown.
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[Ohio Association of Realtors CEO Robert] Fletcher said the 20 percent rule has the potential of knocking 60 percent of the buying public out of the housing market. Because the housing market is a key part of the economy, eliminating low risk buyers from the housing market will create another severe obstacle for the economic recovery to overcome, Fletcher said.
…
However the potential impact if the rules were to go through on the rest of the economy is less people could afford to buy a house if they have to pay 20 percent down or banks might be less willing to lend to them for less. Then demand for houses will decrease.
That last sentence really gets to the heart of the matter for real estate salespeople. It’s not about what’s good for the economy, homebuyers, or neighborhoods in the long term, it’s all about selling more houses. Who cares if they can actually afford it or not, right? Just move the goods, right?
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By deejayoh @ 31:
So using your numbers, if 34 percent of returns itemize, that means that 66 percent take the standard deduction. Married couples filing together on a single return get a higher standard deduction than single filers, so I’m not convinced that the 34 percent of itemized returns really correlates to more than 50 percent of voters taking the mortgage deduction (as you imply it does)… and that’s what it boils down to. What percentage of VOTERS benefits from the laws the way they are versus if it were changed to eliminate the mortgage deduction? Eliminating the deduction should theoretically allow the government to increase the standard deduction while maintaining the same tax revenue. Therefore, everyone who is currently taking the standard deduction (more than 50 percent of the voting population) should benefit from elimination of the mortgage interest deduction. And even if you generously assume that the 34 percent rate of itemized returns represents more than 50 percent of the voting population, some of those voters probably wouldn’t be itemizing if the standard deduction were increased… they’d get more benefit from an increased standard deduction than they get from itemizing.
So in my opinion eliminating the mortgage deduction would not necessarily be a negative from the standpoint of the popular vote.
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By Scotsman @ 93:
They shouldn’t, if those things be quantified as risk factors they could also be used to gauge credit risk. Aging out of the work force certainly can be. Occupational industry and experience could be. Medical fitness could be (e.g. Smoking, weight). Whatever.
But what we have now is a system that is set by public policy, not by effective risk measurement.
A million years ago, banks actually met the borrowers, interviewed them, took a down payment, and fretted over whether they would be paid back before making the loan.
More recently the government declared home ownership a public interest and got into the business of issuing ineffective blanket rules for assessing and guaranteeing borrower credit risk. Someone decided that showing up with two pay stubs and a credit rating was all you needed to prove to the public’s satisfaction that you were good for 30 years of payments on a $400k house. The banks were let off the hook and allowed to originate loans to any warm bodies that passed that test and could sell them (along with the risk) to the taxpayers and forget them.
This is insane. My preference would be for the US to get out of the business of home loans entirely, as it is clearly unfit for the job, and force lenders to really think about who they loan to, how much, and for how long. But if my own tax burden is going to be used to create loans, then at least let us get more intelligent about our standards.
Did you know the US taxpayer is the #1 owner of foreclosed homes?
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RE: Hugh Dominic @ 2 – Sorry, now I’m all fired up and must continue.
It’s not even that the government declared home ownership a public interest. That may have been the case at one time, but now that is just the cover story for industry lobbies, interest groups, and social engineers to use government policy to enrich themselves. These standards have been shaped to maximize their benefit at the expense of the taxpayer, and to leave the average person in tremendous household debt right into their retirement.
The sooner you recognize that, the sooner you will see that these policies that you think you depend on are in fact your worst enemies.
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By David Losh @ 98:
Oh, how I long to be so naive again. You are thinking only of TARP. That was just a sideshow.
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RE: Azucar @ 1 – Another study demonstrates that the removal of the mortgage interest deduction only increases taxes for 23.5 percent of the tax payer units. The mortgage interest deduction is regressive in nature primarily benefiting the financial better off. Removing the deduction results in an average increase in taxes of $559.00. The bottom 20 percentile of incomes would see their taxes increase by a whole $2.00. The next 20 percent by $32.00, the next 20 percent by $215.00, the next 20 percent by $689, the 95-99 percent by $4234.00 and the top 1 percent by $5393.00. Clearly the mortgage interest deduction mainly benefits the financially better off with the largest deductions going to the financially elite. The majority of tax payers units get little or no help from the mortgage interest deduction. Another study estimates that the mortgage interest deduction artificially raises the price of housing by ten percent. Finally, the mortgage interest deduction has done little to nothing to increase home ownership rates. It clearly is a financial boon for the better off and the wealthy at the expense of the rest of the tax payers.
See Table 2a on page 19 for the percentile breakdowns of taxpayer units: http://www.urban.org/uploadedpdf/412099-mortgage-deduction-reform.pdf
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A couple of side issues on the mortgage interest deduction. If you remove the deduction entirely, then given the fairly healthy standard deduction, the deductions for many other things (e.g. state taxes, health care costs, etc.) would become practically meaningless. They could reduce the standard deduction to account for this, hopefully reducing rates at the same time to compensate. But when they start doing things like that, it won’t be as clear who is benefiting and who is paying more. I see that as another benefit to simply restricting the deduction, because there you better know who the change is hitting.
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RE: Azucar @ 1 –
Remember the ****storm that ensued when they tried to reset the top 1%’s income tax 3% higher? People don’t vote strictly by their own self-interest.
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RE: Hugh Dominic @ 104 –
How were we stuck? I don’t get that.
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RE: Pegasus @ 5 – RE: Azucar @ 1 –
You should be debating tax reform. Taking one part of an over all system of tax deductions that only benefit those who use an accountant is like drawing the line between who uses H and R Block, and those who have an individual accountant.
We can all deduct. We can all become our own set of tax write offs, it’s just a matter on whether it’s worth it.
I almost forgot, how does the government owning all those foreclosures become a government issue? Shouldn’t we be looking at the lenders, banks, and investors?
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By doug @ 107:
Actually they do. When that top 1% is paying your way you vote how you are told. Don’t and the contributions into your coffers disappear. Its self-preservation.
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RE: Pegasus @ 110 –
Point taken. I was talking more about the populace in general, but who’s a person to vote for to vote against corporate pandering today?
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On the latter half of the article. I guess that means that VA loans have a super high default rate since they are 0 or 1% down loans. I can’t believe that. Does anyone know the default rate of VA Loans?
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I don’t think either of reforms you are advocating actually make sense — and I’m hardly a Real Estate industry shill.
1. 20% down requirement
I tend think this will lead to less middle class home ownership. Most people cannot afford to save 20% of a house price, which is likely to lead the market for rentals to heat up to where rental properties will be very profitable for people with the cash to buy. The end result (after the current unusual market conditions subside) will not be a deflation in housing prices, but a (even more of) land owner class vs. a rentor class… of course, it will be the land owners who will benefit from that situation — not the people who are forced to save up 20%.
2. Repeal the home interest tax break
What you are not mentioning is that people who buy expensive property also pay higher property taxes. For me, this deduction is approximately a wash with the property tax I pay – so the benefit of buying an expensive house is really just a trade of a federal tax for a local tax.
Maybe a cap on the tax break would make sense. Lets say a $15k maximum deduction with an escalator for inflation. What does that look like?
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I’m a huge fan of eliminating the interest tax deduction, and it makes me few friends. It is where government manipulation of it’s citizens through tax policy hits us all. And, unfortunately, since most people vote their wallets, they are opposed to it. And the electorate always voting their wallets is what has gotten us into the economic mess we are in.
I love the freedom of purchasing what I want and doing what I want based on my ability to afford it and physically do it as opposed to the tax benefit/hit. That makes me feel like a slave to the state, and it is a very icky feeling.
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