The Mortgage Interest Deduction

Happy New Year! Sometime in the very near future, our Congress is going to start picking apart our current tax structure. This examination of allowable deductions is not part of the New Year’s Eve wrangling that is going on as I write this. But, for at least a month, I have been getting frantic emails from Realtor® organizations that the sacred “Mortgage Interest Deduction” is an endangered species that must be protected. (Pardon the mixed metaphor. The hyperbole around this subject has no subtlety.)
I asked my financial planner about whether he took these dire warnings seriously. He said that the deduction will not go away. “It is a political third rail.” No one is going to let that deduction disappear. Then, I asked my tax accountant. He wrote, “Attempting to remove the mortgage deduction would be politically difficult, (if not suicidal).  However, attempting to cap all deductions would be much easier to sell unless the nation’s charities could successfully combat the notion.” The guys I depend on for information about taxes both think this deduction is both necessary and untouchable.
When real estate came up at a party, I mentioned the deduction and got a similar reaction. People see questioning the mortgage interest deduction is equal to saying home ownership is unnecessary to the economy. The deduction, they say, “is huge!” So, it seems that tax-related professionals and the home-owning public see this deduction as very important and a political hot potato.
I asked my tax accountant to explain the deduction, he wrote:

On the most basic level, the mortgage deduction may reduce your taxable income on a dollar to dollar level.  I say may because the amount of the mortgage deduction (plus state tax and other deductions) has to be quantified against the standard deduction. Reducing your taxable income reduces the amount of taxes you pay. 
Usually the mortgage deduction is the vehicle that allows middle class families to itemize their deductions (and thus begin to fulfill the American dream).  The important consideration on this subject to remember is that “the higher your personal tax rate the more significant the mortgage deduction becomes”.
For many people, they could not afford their house or condo if their tax burden wasn’t being reduced by the mortgage interest deduction.  This is part of why you are getting pressure from Realtors®. 

I think differently from most of my real estate agent peers. My first thought about this deduction is that the emphasis on it is way out of date. Houses are not the tax shelter that they used to be. The reason: low interest rates.
Mortgage interest rates have been as high as eighteen percent in my lifetime. But, that’s not so normal. Normal is more like seven to nine percent. It’s just that we have been spoiled in the past fifteen or so years, when mortgage interest rates have been hanging well below six percent for most of this generation of house buyers. 
Let’s do a little math:
Suppose you have a mortgage for $300,000. Your interest payments are front-loaded, so you pay far more interest and far less principal in the earlier years. The tax deduction is on the interest, so you get bigger deductions in the beginning when you are paying interest more and principal less.
If your interest rate is a typical seven percent, your interest in the first year will be roughly $1750 a month – that’s $21,000 in the first year. In year five, it is roughly $1640 a month – that’s $19,680. In year ten, it goes to $1490 – that’s $17,880. At year fifteen, it is down to $1275 — $15,300 annual deduction. These figures are significant tax shelters.
With current interest rates around three percent for 30-year mortgages, the picture is very different. Interest in the first year will be roughly $750 a month – that’s $9,000 in the first year. In year five, it is roughly $660 a month – that’s $7,920. In year ten, it goes to $560 – that’s $6,720. At year fifteen, it is down to $450 — $5,400 annual deduction. It’s a tax shelter, but not like it was when interest rates were higher.
I am not jumping up and down screaming that the mortgage interest deduction is vital to the housing economy. I am being a rebel without a cause?

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