Debating the Mortgage Interest Deduction

Mortgage-RateMitt Romney lost the election but some of his fiscal ideas may survive.  Mitt Romney’s comments on an Iowa radio station re-ignited the debate about the mortgage interest deduction (MID) that has been simmering since at least 1984.  Romney’s plan calls for a $17,000 deduction budget that effectively caps and may even kill the MID:

 As an option you could say everybody’s going to get up to a $17,000 deduction. And you could use your charitable deduction, your home mortgage deduction, or others — your health care deduction, and you can fill that bucket, if you will, that $17,000 bucket that way. And higher income people might have a lower number.

The MID inspires deep passions.  It is also not likely to be received by the public with any objectivity.  The National Association of Home Builders (NAHB)  released a poll showing that the MID was supported by 77 percent of Republicans, 71 percent of Independents and 71 percent of Democrats.  Real estate lobbyists have been arguing for some time that eliminating the MID while the housing market is weak would further destabilize housing.   However home prices and interest rates are so low right now that the benefit that the deduction provides to buyers has been significantly minimized.  As a result, there are new calls that now is exactly the right time to restructure the deduction.

The MID is a huge, off the books subsidy, estimated at $98 billion this year, about which we really know very little and assume a lot. Is that wise?  The MID is estimated at approximately $800 per household this year, but the benefits can vary greatly.  Only one quarter of all tax filers claim it as you have to itemize your deductions. As a result, the top 20 percent of American households get 75 percent of the benefit from the MID, according to The Atlantic’s Matt O’Brien.

Support for the MID is tied up with our support for homeownership.  Homeownership is a worthy goal that signals community stability and commitment.  Investors and corporations look at homeownership rates as a key indicator for economic development.  The problem is that we really haven’t questioned whether the MID actually increases homeownership. By offering a break on mortgage interest do we actually promote homeownership more broadly? Does the deduction of loan interest encourage people to maintain their homes better or should we consider more direct deductions for maintaining and improving homes?

These are tough questions to answer and it is likely that clarity is unattainable on this issues.  It is also possible that the cure may be more harmful than the disease.   At the very least, it would be helpful to outline the pros and cons to provide more meaningful consideration of the benefits and costs of the MID.

Pros of the Mortgage Interest Deduction

  • Eliminating the deduction, or even reducing it would cause home prices to fall at least in the short run.  Lawrence Yun of the National Association of Realtors, argued against the Simpson-Bowles plan to cap the deduction saying that reducing the deduction would depress prices as buyers realized they could not afford as much house without the deduction.
  • A change to the deduction would hurt existing homeowners. If they wanted to sell, they would in theory get less for their house because the value of the deduction would no longer be included in the price.  New homeowners would be able to afford less house for their money.  The effect however will vary with the balance of supply and demand at different price points.

Cons of the Mortgage Interest Deduction

  • A 2010 study by researchers at the London School of Economics and Kansas State University found that the MID is not an effective policy to increase homeownership rates.  “… the mortgage interest deduction boosts homeownership rates only in areas with an abundant housing supply, like the Midwest — but only for higher-income households. In denser urban cities with limited housing available, the deduction actually has a negative impact, reducing homeownership and instead inflating housing prices.
  • Australia, Canada and Britain have higher rates of homeownership than the United States and they have no allowance to deduct the interest on mortgages from taxes.  Other European countries also have higher rates of homeownership with less government support that generally reflect cultural norms or discrimination against rental housing.
  • The comparison in Figure 1 shows that the value of the MID increases dramatically as the interest rate increase and as the size of the mortgage increases.  Figure 2 indexes the MID savings to the base of a $100,000 mortgage at 5 percent interest.  The index clearly shows that the value increases with the size of the mortgage but it is even more valuable with higher interest rates.  These estimates were produced from a tax deduction calculator from to avoid any concern that the numbers were manipulated.
Figure 1

Value-of-the-Mortgage-Interest-DeductionSource: Tax Deduction Calculator


Figure 2

Mortgage-Interest-Deduction-IndexedSource: Tax Deduction Calculator


Now that you have had a chance to hear the pros and cons and maybe even checked out some of these sources yourselves, consider taking a short survey that asks which arguments you think are most believable and important, as well as what you think is missing.