Tuesday, May 26, 2009

Mortgage Interest Deduction Doesn't Make Sense (to Me)

We take advantage of the mortgage interest deduction. We considered the impact of the deduction when we determined what we could afford to pay for a house. If the deduction went away, we'd be screwed. I suspect, however, that the deductibility of mortgage interest was somehow factored into the price of our house before we bought it and that we simply paid more for the house than we would have if mortgage interest hadn't been deductible. The real beneficaries of the deduction are real estate brokers and mortgage lenders, since they get bigger commissions and write bigger mortgages.

If the mortgage interest deduction were repealed, it would probably result in a significant fall in the value of houses. Unless existing mortgages were grandfathered in, there would be a glut of houses on the market as folks tried to unload houses they could no longer afford. There doesn't seem to be a way out at this point. The suppression of the wealth effect that comes from elevated home equity would hurt the overall economy.

Yet, the mortgage interest deduction does not appear to serve any useful purpose. It doesn't really promote home ownership since house buyers are paying up front for any value added by the deduction. Moreover, why would the government want to promote house ownership in the first place? What's it to the federal government if I own or rent? If I own, and there's an economic downturn, I'm stuck in my house and can't readily move for a job. If I rent, I'm more mobile.

Are house owners supposed to be better citizens? Do they yield more revenue to the government as a result of their owning a house?


D. Saul Weiner said...

Good post. Of course, if existing houses were grandfathered in, then that would hurt new home sales, so the builders and related interests would never stand for that either. I would say that the only somewhat practical way of reversing it would be to phase out the deduction over say 20 years. Since mortgage interest goes away over (at most) another 30 years (assuming people aren't taking out longer mortgages), that would allow prices to transition over time instead of falling off a cliff. But this is a good example (as if we need one) of a dubious intervention which appears on the surface to offer a benefit to the average Joe but doesn't really, but is nevertheless almost impossible to kill.

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