Subsidizing Home Ownership
When looking for culprits for the subprime mortgage crisis, there’s plenty of blame to go around. The bulk of the responsibility must lie with everyone (borrowers and lenders alike) who assumed home prices would keep going up forever. But there’s plenty of room to discuss secondary culprits, and I’d like to add my candidate to the list.
The mortgage interest deduction is supposed to subsidize home ownership, but instead it subsidizes very nearly the opposite of home ownership. What the mortgage interest deduction subsidizes is carrying large amounts of home mortgage debt, meaning that the bank owns far more of your home than you do. This does make it easier to buy a house, but once you’ve bought it, it gives you a strong incentive to avoid accumulating equity in your home. Cash-out refinancing is subsidized by the mortgage interest deduction every bit as much as home purchases are. The mortgage interest deduction gives people every incentive to live up to their necks in debt.
If we really wanted to subsizide home ownership, mortgage principle (including downpayments) would be deductable, not mortgage interest, and cash-out refinancing would be taxable income. Basically, equity in a primary residence would be treated like a 401(k) without the 10% early withdrawl penalty.
At current interest rates, the total subsidy of a mortgage principle deduction over the lifetime of a traditional 30-year fixed mortgage with a 20% downpayment would be about the same as the total subsidy on the same mortage of the current mortgage interest deduction, so this is revenue-neutral and subsidy-neutral if we phase it in carefully (say, grandfather existing mortgages and allow homebuyers over the next year or two to choose between the old system and the new).
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4 comments
The down payment deduction is a decent start; however, for most home owners those first ten years or so the checks they mail out are almost all interest and escrow with a small amount going to principal, so you’re still raising the bar higher for home ownership, some politicians universally view as a "Bad Thing".
J.A. Eddy’s last blog post..?A trillion here, a trillion there and soon you?re talking real money.?
True. Even if you use the downpayment deduction to make a larger downpayment, the first few years’ payments will be quite a bit higher without the interest deduction.
The key to selling this would be to argue that the proposal encourages building equity while the current system discourages it, and by pointing to the current level of foreclosures and short-sales as evidence of the dangers of encouraging people to "own" houses with little or no equity.
It’s a pretty big windmill you’re tilting against there. Again, you’re talking common sense, but common sense and politics often have very little to do with one another. Most people will see it as "With the interest deduction I can make the payments. With the Principle deduction, I can’t." For them, and most politicians, that’s the end of the argument.
J.A. Eddy’s last blog post..?A trillion here, a trillion there and soon you?re talking real money.?
What if you allow the downpayment deduction to be taken over the course of several years? At a 6% interest rate, the principal deduction for the downpayment spread over six years just about replaces the interest deduction for those years.
Which still leaves you with a problem in years 7-18, when you’ve exhausted the deduction for the downpayment, but principal payments haven’t caught up with interest payments yet. Damn.
I’d need an additional selling point to make this anything like politically viable. Maybe if you turn it into an above-the-line deduction, allowing homeowners to continue to take the standard deduction. But that breaks the revenue-neutral nature of the policy, and I’d prefer net tax cuts be rate reductions rather than expanded deductions.
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