With the start of the new Trump administration quickly approaching, everyone is anticipating the policy changes that the upcoming president has in store. For home owners, they can expect a “big tax cut for the middle class” in the form of mortgage interest deduction caps.
“We’ll cap mortgage interest, but we’ll allow some deductibility,” said Steve Mnuchin who is currently in consideration as Trump’s Treasury Secretary, "Any reductions we have in upper income taxes will be offset by less deductions so that there will be no absolute tax cut for the upper class."
The current mortgage interest deduction policy—a legacy of the Reagan administration—allows homeowners to deduct interest payments on their home loans from their income taxes. Law makers avoided reforms on this deduction due to its popularity, especially in the real estate industry since this has been promoted as an incentive for home buying. The Trump administration, however, aims to propose a cap on mortgage interest deduction for two reasons—foregone taxes of about $96 billion which is costly to the U.S. government, and more importantly, the fact that the rewards of this system are typically exclusive to the rich and wealthy.
This is seen in the numbers, according to the Tax Policy Center. Currently, home ownership stands at 62% of the population—173 million homeowners. Out of that group, only 22.5% actually benefit from mortgage interest deductions. This group mostly comprises of the rich who are able to secure large sums of mortgage payments, allowing them more deductions from their income taxes. For the middle- and lower-income families, however, they don’t gain as much since their mortgage debts aren’t as large. Some do not even possess a mortgage or pay federal income taxes, meaning that they cannot even qualify for a deduction.
This all leads to a severe implication in real estate—that mortgage interest deductions are rewarding to the rich who are able to purchase more homes and can simultaneously qualify for large tax deductions. This causes an excessive demand for homes which increases prices, especially in tight markets like New York and San Francisco.
In an interview, Kyle Pomerleau, Federal Projects Director of the Tax Foundation, explained how the new administration’s proposed changes will work. “Trump’s tax plan does effectively limit two itemized deductions without explicitly doing so,” he said, “By increasing the standard deduction, it reduces the number of itemizers.”
What does this mean? For example, someone pays $10,000 in mortgage interest for the first year. This exceeds the $6,300 standard deduction, so that person can itemize the deduction to claim a tax break. Should Trump increase the standard deduction to $15,000, then there would be no need to itemize the mortgage, thus simplifying the tax filing process. This can eventually lower house prices, pushing current home buyers to purchase bigger homes or spend more on housing.
“They might still own the house, but they won’t pay as much,” as Roberton Williams of the Tax Policy Center explained.
Mortgage Bankers Association chief economist Michael Fratantoni welcomes the change which can simplify the tax code since it lowers the cost of interest on an after-tax basis. Todd Sinai of the University of Pennsylvania’s Wharton School also identifies an advantage to Trump’s proposal, saying that a simplified tax system allows more Americans—especially low-income earners—to gain more savings which they can use for other investments.
On the contrary, the proposed cap in mortgage interest deductions has received criticism from industry leaders, particularly from William E. Brown, president of the National Association of Realtors who argues that this can discourage Americans from buying homes since there will be a small price difference between buying and renting.
"We would strongly oppose any attempt to limit or eliminate the mortgage interest deduction,” he said, “Realtors know that the MID is an important benefit not just for the millions of current homeowners who depend on it, but also for renters looking to make the transition into homeownership. Doing anything that would limit incentives for homeownership is a fundamental step in the wrong direction that could harm home values and keep more buyers on the sidelines.”
Brown speaks for other real estate industry leaders who sees this plan as a potential barrier for entry in the market, specifically for millennials who are seen as the key to speed up the housing recovery. Because of high levels of student debt, low wages and a combination of increasing home prices and mortgage interest rates, realtors struggle to convince millennials that buying a home is a good investment. A cap in the mortgage interest deduction can further hinder their sales.
For now, the challenge for the Trump administration is clear: to promote inclusive growth for all Americans, including low- to middle-income earners. This involves not only simplifying the tax code, but making homeownership affordable and more rewarding to prospective buyers. On a more optimistic note, perhaps having a real estate mogul as a president may be an advantage for the industry, and so we can expect to hear more plans from President Trump in the months to come.