Tuesday, February 24, 2009

Mortgage interest

Thomas Schaller, a Sun editorial writer who has traveled far down the road to serfdom, reminds us today that every blind squirrel sometimes finds a nut. His criticism of the mortgage interest deduction is right on target.

But the mortgage crisis also reveals the dark underbelly of the mortgage interest deduction. For one thing, it disproportionately benefits high-income earners who buy expensive homes. In 2003, taxpayers with incomes over $75,000 filed 16 percent of all tax returns yet accounted for 54 percent of the deduction's total tax savings; the 52 percent with incomes under $30,000 claimed just 9 percent of the tax savings.

This tax benefit also encourages people to buy a bigger house than they otherwise might afford. Indeed, because the deduction applies regardless of whether the borrower pays a high or low interest rate, makes a big or small down payment, or pays down principal monthly or opts for an interest-only loan, the mortgage deduction has the perverse incentive of rewarding higher-interest, lower-down-payment and interest-only loans - precisely the sorts of loans that got many Americans in trouble in the first place.

The worst legislation often has two fathers: misinformed, but well intentioned do-gooders and special interests. The home mortgage interest deduction is a clear example of this. Do-gooders want to do everything they can to encourage home ownership, and the mortgage lenders and residential homebuilders are happy to reap the benefits of such ill-conceived ideas as deductible home interest. Baptists and bootleggers.


PZGURU said...

FM - I think that's an interesting way of looking at it, but I can't quite agree 100% with you on your pespective or the article writer's perspective. If I am misunderstanding the point, accept my apology in advance.

It is true that a more expensive house, or a mortgage with a higher finance rate would both enable someone to have a bigger tax write off, but there's more to this than the up-front numbers. Tax write offs are not the same as tax refunds. If I claim $1000 in write offs, my tax debt is only reduced by (approx.) $300 (depends on my income bracket). I don't get a 1:1 rate of return on the write off.

If people are actually buying a bigger house or purposely accepting a loan with a higher rate just to get a bigger tax write off, that makes no sense. Thay are essentially a lot more in expenditures to a get little more back in taxes. A bad "investment" strategy in my opinion.

Similarly, I know of people who actually want to keep a mortgage as long as possible so they have a tax write off. Again, this makes no sense to me since you don't get a 1:1 return. If I could afford to pay off my mortgage early, and lose that tax write off, I would. The money I could save each month by not having to make a mortgage payment at all far outweighs the loss of my tax write off benefit.

Freemarket said...

The point is this: assuming you have a marginal tax rate of around 30%, an additional dollar in mortage interest expense only costs you 70 cents. The mortgage interest deduction essentially gives everyone a 30% off sale on their mortgage rate. Lowering the price of something causes people to consume more of it, which played a role in the mortgage crisis.

It actually does make sense to hold a mortgage as long as possible if you can get a higher return on your money elsewhere. Why pay off a 5% mortgage early when you can invest in the stock market and get 10% over the long haul? I know, that is not a good argument with the performace of the stock market as of late :-)

PZGURU said...

I do agree with your last thought about an investment that might have a better rate of return than the mortgage rate. I knew I had forgot something in my take on this.

I doubly agree that there are few investments these days offering a 5% rate of return. I'd be happy with 1%, or anything better than the -15% I've been hit with over the last year. COL (cry out loud)!