It’s time to eliminate the mortgage interest deduction

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4 min read

Throughout my career, my affordable housing colleagues and I have avoided all mention of the Mortgage Interest Deduction (MID). Whatever we might have thought about it privately, in public our lips were sealed.

Five years ago, my mental boycott of evaluating MID ended – and the more one thinks about it, the worse the MID looks as national policy. Consider that:

  • The MID is the nation’s fifth largest tax expenditure, costing over $105 billion annually. That’s more than double the HUD budget and more than ten times the annual cost of the low-income housing tax credit.
  • The MID has been festooned over the years with ornaments of dubious policy justification. Second homes qualify (including vacation homes), as do – believe it or not – RVs and yachts if they have “sleeping, cooking, and toilet facilities.”
  • Economic evidence abounds that the deductibility of mortgage interest simply causes higher home prices. Home prices are controlled mainly by the cost of monthly payments (debt service + real estate taxes + imputed yield on the equity), not by the sales price. If the MID went away and the market found new equilibrium, people would still pay the same percentage of their income for total housing costs.
  • The MID’s impact on home prices is affected by the volatility of interest and inflation rates – it increases home-price beta. That exaggerates boom-and-bust risk.
  • By place-basing the assistance, the MID encourages over-investment in hot markets.
  • The MID widens our national discrimination against rental. Rent payments are non-deductible, but the same sum paid as mortgage interest on exactly the same dwelling space is deductible, even though most of it should be considered “imputed rent” because the homeowner lives there. Increased home-price volatility, place-basing of assistance (encouraging price spikes), and the bias against renting mean that people who would have been better off leasing instead took on too much debt (with explosive embedded features) to grab onto homeownership at prices they could not afford. The MID deserves indictment as a co-conspirator in the subprime debacle.
  • The MID is one of the nation’s few regressive social benefits. Though capped at interest on $1,100,000 in mortgage principal, it benefits the rich more than the poor.
  • The MID encourages longer-term loans and serial refinancing. It discourages the early payoff of home mortgages, among the safest and best ways for a family to reinvest disposable income.
  • The MID motivates people to bet their house over and over again. It encourages cash-strapped households to borrow more against their home to cover bills, since mortgage interest is deductible while credit card or consumer finance debt is not.
  • The absence of the MID has not deflated housing markets in other countries. In Canada and Australia, homeownership rates are similar to ours, homes prices are stable and rising, and leverage is 15%-20% lower than in the U.S.

A Path Forward

Yes, you may think, if we could wish away the MID, we should…But the transition will be bloody and sabotage the fragile housing recovery.

That fearful reasoning lacks an evidentiary foundation. The U.K. phased out its MID during 1974-1999. The result? Leverage declined. Real home prices (inflation-adjusted) didn’t.

The U.S. can withdraw safely and smoothly from the MID, using any combination of the following:

  • Grandfather loans made before a certain date (say, December 31, 2012) and allow mortgage interest deductions for them over a fixed time period to maturity.
  • Gradually lower the total mortgage debt eligible for the MID – say, $100,000 annually down to $500,000, and then $50,000 per year the rest of the way to zero.
  • Immediately prune all MIDs from anything but the taxpayer’s principal residence (the one you sleep in 183 or more nights a year).

Once one realizes that the MID is harmful, one is imbued with an urgency to kill it when the opportunity arises – and this is our best chance in forty years. Support for housing prices today is not coming from an explosion of mortgage credit; if anything, it’s equity-based entrants who are the home buyers. At 4.25% or so, today’s interest rates cost less, even if we ignore the MID entirely, than the 6.50% rates of five years ago would cost even with a full MID. And our nation’s current, staggering budget deficits are imperiling the country’s economic future.

The MID must go. Let’s do it now.

David A. Smith is Chairman of Recap Real Estate Advisors, a Boston-based real estate services firm that optimizes the value of clients’ financial assets in multifamily residential properties, particularly affordable housing. He also writes Recap’s free monthly essay, State of the Market, available by emailing [email protected].

David A. Smith is founder and CEO of the Affordable Housing Institute, a Boston-based global nonprofit consultancy that works around the world (60 countries so far) accelerating affordable housing impact via program design, entity development and financial product innovations. Write him at [email protected].