Honey, I Shrunk The Mortgage Interest Deduction – Plan 1

The political landscape this year has been nothing but ugly. It promises to come to full boil with the proposed tax reform eliminating or reducing the mortgage interest deduction.

Tax Reform or Raising Taxes

There is an old saying about the two political parties. Democrats raise taxes while Republicans reform taxes. In both instances, we end up paying more money. In a very brave move, a bipartisan committee is recommending tax reform that goes after the beloved mortgage interest deduction.

The committee looking into tax reform was given a directive by President Bush to simplify a tax code that is universally agreed to be a disaster area. You may not realize it, but two additional sections are added to code every day on average. One of the particular problems is the Alternative Minimum Tax, which was originally designed to keep super wealthy people from avoiding taxes. Because it was written poorly, the AMT now affects a large percentage of people. The problem, however, is how do you get a make up for a tax that produces millions of dollars in revenue for the government?

The committee†s answer is to go after the mortgage interest deduction. The committee has offered two plans and we†ll look at the first one here.

In the first plan, the mortgage interest deduction would be reduced to a figure related to the loan amount the FHA will back. The FHA was set up to help low income individuals get homes, which means the effective cap on the deduction would be very low. In San Diego, the average single-family home costs in excess of $600,00. The FHA cap for the city is around $315,000, which means homeowners would lose approximately half of their deduction. In expensive real estate areas, this will mean many people will lose the ability to make their mortgage payments, which means defaults. With borrower defaults will come the end of the housing market boom. The loss of equity will, of course, cause many people to go upside down on their loan, which will be another disaster.

If Congress pursues a cap on the mortgage interest deduction, chaos will reign. It is hard to imagine this option being adopted by the politicians.