Is It Time to “Repeal and Replace” the Mortgage Interest Deduction?

Affordable-housing advocates say this pillar of our housing policy is ripe for reform. Specifically, it should be capped and converted into a tax credit so more homeowners can benefit from it.

If Congress is proactive, the possibility of productive tax reform in 2017 could very well become a reality. It’s necessary, too – particularly in the housing market, where the lack of resources to make housing affordable for lower- and middle-income families is growing. But where should reform begin?

A great starting place is the mortgage interest deduction (MID). Once untouchable in the political world, the MID is ripe for revision, and many people across the political and socioeconomic spectrums agree.

“For years, the MID was considered an untouchable third rail program – that’s no longer the case,” says Diane Yentel, president and CEO of the National Low Income Housing Coalition (NLIHC). “In discussions of comprehensive tax reform, key Republican policy makers are actively considering a number of direct and indirect changes to MID.”

NLIHC relaunched the United for Homes campaign as a call for the rebalancing of the MID. The campaign’s proposal aims to modify two crucial aspects of the MID as it currently stands: the $1 million cap on mortgages eligible for a tax break, and the deduction itself.

The first modification would lower the cap on the amount of mortgage for which homeowners can deduct interest from $1 million to $500,000. According to Yentel, this would impact fewer than 6 percent of mortgage holders nationwide, most notably in New York and California.

The second modification entails transitioning the deduction into a 15 percent non-refundable tax credit.

In terms of reducing the mortgage cap, statistically speaking, it just makes sense. Across cities, counties, and states, there is a shockingly low number of individuals whose mortgage loans exceed $500,000. In fact, according to NLIHC, only 5 percent of mortgages nationwide exceeded $500,000 between 2012 and 2014.

With the exception of the District of Columbia, Hawaii, and California, every other state in the country had less than 10 percent of mortgages exceeding $500,000 during this period. In Pennsylvania, a mere 1.5 percent of mortgages exceeded $500,000, and in 18 other states, this number fell below one percent.

But what do these numbers look like for our region specifically? 

In Philadelphia County, between 1.1 and 3 percent of mortgages exceeded $500,000. Bucks, Montgomery, Delaware, and Chester counties surpassed Philadelphia, but not by anything worthwhile. Each county had between 3.1 and 10 percent of mortgages exceeding $500,000, and all four counties together were the only four to even reach this range. A whopping 57 of Pennsylvania’s 67 counties had less than one percent of mortgages exceeding $500,000.

Not only does a $500,000 cap seem necessary, it also seems logical.

We’ve tackled the mortgage cap, but what’s the big deal about having a tax credit instead of a tax deduction? Well, the credit would benefit 15 million more homeowners who are currently unable to receive any tax benefit at all, because they don’t make enough money to itemize their deductions – a crucial part of the MID. Another 10 million homeowners would enjoy a larger tax cut than the one they currently receive, Yentel adds.

“These two changes together would save $241 billion over ten years, to be reinvested into affordable rental housing solutions for the lowest income people, while giving a tax break to 25 million [more] homeowners,” Yentel says.

If you’re still confused about why reforming the MID matters, we’ll put it simply: the MID disproportionally benefits higher-income households, and excludes (or almost excludes) most lower- and middle-income households.

Higher-income households tend to have larger mortgages, which makes sense. But, because of the way the MID currently works, these larger mortgages allow for the homeowners who take them out to take larger deductions for their interest payments. That’s where the problem arises. While lower- and middle-income households, a.k.a. the people most likely to need financial assistance, are missing out on this tax break because they don’t earn enough to itemize, wealthier households are reaping benefits they don’t really need.

All the MID seems to actually be doing is encouraging people to take on higher levels of debt in order to get larger tax breaks.

Some opponents of reforming the MID falsely believe that it helps incentivize homeownership, and Yentel discredits this belief completely. “A powerful mythology has been built around the MID: that it was created to help people realize the American dream of homeownership (it wasn’t), that it incentivizes homeownership (it doesn’t), that it is targeted to those who need it (it isn’t) and that, as currently structured, it’s a reasonable use of federal resources (it’s not),” she says.

And the MID issue isn’t a political issue, either. Regardless of your political beliefs, reform will benefit the common good of everyone.

“Conservatives who want to see a simpler tax code should support reforms that do just that, as these reforms would put more money back in the hands of their red-state constituents,” Yentel says. “About half of all spending through the MID benefits a small number of high-income households in blue states. Progressives who are committed to addressing growing income inequality should support reforms that make the MID fairer for more families.”

It doesn’t really matter who you are or where you’re from. The time to reform the MID has come, and that time is now.