The mortgage-interest deduction is the latest housing policy Congress is targeting for possible cuts that could have a deep effect on the nation's housing recovery. For California, this feels a lot like a "kick us while we're down" move by Congress. Don't panic yet, though. Talk is cheap and this is an issue that has come up before – each proposal getting nowhere. Let's look at what's happening here.
First, what is the mortgage-interest deduction? It's part of the tax code that enables homeowners to deduct the interest they pay on their mortgage from their income tax bill each year. It provides a nice deduction for those in high-cost areas like California and is a significant incentive for home buyers as they know they can count on this deduction to help reduce their annual tax bill.
Sounds good, right? So why cut it?
The mortgage-interest deduction is the largest single subsidy for housing in the U.S. and is projected to reduce tax revenue by $131 billion in 2012. It's easy to see why Congress would be interested in gaining back some of the revenue.
The proposal that sparked the whole discussion early in November would reduce the amount of mortgage debt on which a borrower could deduct interest paid from the current limit of $1 million to $500,000. Also, borrowers could no longer deduct interest paid on home-equity loans or on mortgages for vacation homes.
The upside is the immediate pool of revenue this would create for a Congress that's dealing with major deficits. However, pulling it from the hands of homeowners is a pretty bad move that could seriously derail an already-slow housing recovery.
With more than 11 million U.S. households now holding a mortgage worth more than their home, according to CoreLogic, taking money from homeowners is an obvious bad idea. And even though the proposal is simply to lower the current cap, it's still a pretty drastic move that would significantly impact different segments of the market.
Proponents of the cut argue that only higher-income homeowners actually benefit from the deduction because those in the middle or lower-end tend not to itemize deductions on their tax bills anyway – opting instead for the standard deduction. They say that high-cost states are the ones that would be most impacted by a move like this.
I say it all depends. Many times moves like this will do more damage by sheer perception than actual numbers. The government takes away one of the largest incentives for buying a home. That's bound to crush more consumer confidence.
So please, Congress. Think before you act on this. Housing is a work horse in our national economy. Don't make a hasty move in order to fix another problem.