As part of simplification of income taxes, eliminating the mortgage interest deduction should be at the top of the list. This will be difficult to accomplish, as the real estate industry pitches the deduction as a way to help middle-class families afford home ownership.
The math, however, doesn’t add up. Consider a family of four. Its standard deduction for federal income taxes is $11,900. Itemizing deductions — which is what you must do in order to received the mortgage interest deduction — is beneficial only when the deductions exceed the standard deduction amount.
With interest rates for a 30 year mortgage at 3.356 percent APR (Wells Fargo 30 year fixed), $11,900 of interest payments implies a mortgage loan of $354,000. For a 15 year fixed loan, it would be $406,000.
The national median sales price of a house, according to the National Association of Realtors, is $178,600. In many parts of the country like Wichita, it’s much less. The mortgage loan amounts calculated above are beyond the reach of most middle class families.
But once you start itemizing deductions, most families will have additional amounts to deduct beyond mortgage interest, which means additional tax savings. But families should also be aware that the benefit of these deductions exists only for the amount above the standard deduction threshold. So if a family was able to deduct $14,000, the marginal benefit is only $2,100.
Then, many people seem to believe that income tax deductions like mortgage interest are deducted from the tax bill. That describes the mechanism of tax credits. Mortgage interest is a deduction from income. After the deduction, there is less income to pay taxes on, and that’s the benefit.
The amount of the benefit, however, for middle class families is small. Most of these families probably fall into the tax bracket where the marginal rate is 15 percent, meaning that a dollar’s change in taxable income changes taxes by 15 cents. So $2,100 of additional deductions saves $315 in taxes.
There’s another policy consideration. The mortgage tax deduction incentivizes borrowing to buy a home, not the actual ownership.
The mortgage tax deduction is seen as promoting home ownership, which has been a goal of government for a long time. A few years ago we saw what happens when government intervenes in markets like housing. Most people are perfectly capable of deciding for themselves whether to be renters or owners. The government should stop social engineering programs that sway people to act one way or another, and the home mortgage interest deduction is a prime example.