Should Mortgage Interest Be Tax Deductible at All?

by JT McGee

What makes mortgage interest better than other kinds of debt?

I mean, really – is home ownership something worth subsidizing? Does it really get subsidized at all?

Home Prices and Subsidies

I’ve always thought home prices were irrational. At the basis, a home is a way to escape a rental payment. You own, or you rent. You pay X, or you pay Y.

In many cases, owning a home crushes renting a home. In a select few cases, renting beats owning. I get that.

But I also get that homes share a very weird relationship with the cost to rent. Here’s a chart of the historical relationship between home prices and rental prices.

Leading up to the bubble, home prices were arguably too low. During the bubble, home prices were too high. Home ownership didn’t change all that much – it was only a few percentage points from top to bottom – but eagerness to own a home did change. Everyone had a home loan, or several home loans.

A home became something more than its economic value of a way to escape a rental payment. It became part of the American dream. And everyone wanted that American dream at one time. Despite having so much land on the outskirts of most American cities, rapid changes in demand for homes can push the value of any ordinary home well above its cost of replacement.

Simple economics tells us that a commodity cannot be priced higher than its cost of replacement for a very long time. Common sense tells us that homes should be rationally priced on a price to rent basis.

Some variables do change. More people have more student loan debt. Careers have been replaced with jobs. More people have to care about a shorter period of time, so renting beats owning. But homes always have an intrinsic value derived from the avoidance of a rent payment.

Home Economics

Everything is based on supply and demand in rational markets. Housing, being as irrational as it is, tends to be something that Americans love to reach too high to buy. So in “subsidizing” home mortgages with tax deductions, Americans just buy more home than they would before. People simply pay more for a home, since the cost of financing a home is lower with a deduction than without.

The above chart and earlier paragraphs are my logical connection here. People will pay whatever they have to pay to buy a home.

So I don’t think anyone actually benefits from a deduction. The only people who do are the real estate agents who sell slightly more expensive homes than they otherwise would. And bankers who lend slightly more cash per home than they normally would.

Maybe car companies benefit in some way, since homes tend to be the same size as they always were, but with a massive garage on the side. The front porch was so 1940s; it’s all about the garage now!

I’m getting off on a tangent.

The point is this: no one really benefits from a subsidy on home mortgages. The only people who do are the people who buy the most expensive homes. So unless you’re a mortgage broker, a real estate agent, or a politician, there’s really no reason to support a tax deduction on mortgage interest.

{ 4 comments… read them below or add one }

Financial Samurai July 16, 2012 at 12:12

I’m so thankful that up to $1 million of mortgage indebtedness is deductible! Just finished a post about this yesterday which I will publish this week probably since rates are so low again.

The subsidy will always remain as the government wants to encourage homeownership.

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PK July 17, 2012 at 01:01

I agree with you, no. But, like the Financial Samurai says above, I make out like a bandit. Think about it – people in high tax states like California can deduct the full amount of their mortgage since our income taxes are already forcing us into itemizing – married or otherwise.

So yeah – you guys are subsidizing us. Thanks!

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20's Finances July 18, 2012 at 19:57

And I am thinking that I could use a larger subsidy in my neck of the woods. Maybe you’re right, but do you think people think about the deduction when they say, “Let’s get a little bigger house than we can afford.”?? (They may, I’m not sure what goes through their brains).

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Dominique Brown July 22, 2012 at 15:07

JT,

The mortgage interest tax deduction exists, for the same reason we have religious organization classified as non-profits and we have corn subsidies. Congress tends to discount things they feel are for the greater good. Aka.. religion tax loophole and mortgage interest deduction. The same goes for student loan interest deductions. Are they needed? Depends on what side of the coin you’re on. The reason why home subsidies, religious subsidies and student loan subsidies won’t go away because they will be political suicide.

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