No Mortgage Interest Deduction: What’s the Impact?

May 5th, 2011 Brock Hailes Leave a comment Go to comments

Once again, politicians are talking about doing away with – or at least limiting – the mortgage interest deduction. Yanking the deduction away suddenly would be disastrous for people who bought houses figuring the interest deduction as part of the equation. Many middle class families would suddenly owe $5,000 or more per year in additional taxes. The housing market, already reeling, would fall farther. As these hard-hit families have less to spend elsewhere, the economy would dive.

You can stop worrying about a sudden elimination of the deduction altogether. It’s not going to happen – it would be political suicide. That won’t keep the government from tinkering with the rules, however.

Proposed Changes to the Mortgage Interest Deduction

The safest place for politicians to raise taxes is by limiting deductions for the “rich.” The mortgage deduction is already limited to interest on the first $1,000,000 of mortgage indebtedness. A current proposal is to bring that limit down to $500,000. In some parts of the country, where a new house still sells for less than $200,000, that would affect almost no one. In other areas, for example in San Francisco, a median-priced home costs over $600,000. An arbitrary $500,000 nation-wide limit would hit many decidedly “non-rich” families hard.

Another proposal is to give lower income taxpayers a credit in lieu of a deduction. If you qualify, you may actually benefit more from a credit than for a deduction. Deductions only decrease your taxable income; credits directly reduce your income tax bill, usually by a percentage of the expense.

What Should I Do?

If your mortgage balance is less than $500,000 and your income places you in the middle class, you don’t need to do anything. Your deduction is not likely to change, or if it does, it will be replaced by some kind of credit.

If you’re considering buying a home with a mortgage of more than $500,000, be aware that you may not always be able to deduct all the interest. You may want to start paying down your mortgage as soon as possible.

It’s never been a great idea to buy a larger home than you can comfortably afford or keep a large mortgage balance just to get the mortgage interest deduction. Talk of reducing the deduction may help convince more homebuyers to stay within their means.

Remember that even if your mortgage is over the limit, you can still deduct the interest on the amount up to the limit. For example, currently you can deduct interest on the first $1,000,000 of mortgage indebtedness (plus interest on $100,000 in home equity loans). If your first mortgage has a balance of $1,000,001, you deduct all but the interest on the $1, which is insignificant.

What if I’m a Renter?

There’s also talk of implementing a renter’s credit. Renters already benefit from the mortgage tax deduction taken by their landlords, however. If investment property owners couldn’t deduct mortgage interest, they would have to charge renters significantly more. A renter’s credit is likely to be a symbolic gesture, if it is passed at all.

Other than a possible small renter’s credit, changes in the mortgage interest deduction laws shouldn’t affect you directly. If the deduction for homeowners is limited or taken away, the change would almost certainly not apply to investment property owners.

Sally Herigstad is a certified public accountant and the author of Help! I Can’t Pay My Bills: Surviving a Financial Crisis (St. Martin’s Griffin). The book was inspired by students of her personal finance class who said they wanted a no-nonsense, easy-to-read book that would help them take control of their finances – and get through the month without having the power turned off.

Sally continues to stay in touch with the problems of real people by responding to letters from readers of her CreditCards.com column. They write to her about everything from mysterious charges on their Visa bills and unflattering credit scores to broken hearts and nasty credit collectors (too often all at the same time), and Sally gives step-by-step advice for getting out of trouble and avoiding it from now on. She also writes regularly for MSN Money, Interest.com, RedPlum.com, and other publications.

She is a member of the Washington Society of Certified Public Accountants and the American Institute of Certified Public Accountants. Her Web site is www.helpicantpaymybills.net.

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