How tax reform will affect your mortgage

As the Conference Committee works to reconcile the versions of the House and Senate versions of the 2017 Tax and Jobs Act (the “Tax Reform Bill” or “Bill”) many critical questions facing the mortgage industry remain uncertain, though few experts expect it to have a positive impact on the industry. In fact, many experts believe the 2017 Tax and Jobs Act will drive home prices down in some of the nation’s highest priced housing markets and potentially make homeownership less appealing to many Americans.

Chief among the Bill’s changes that may drive down prices or suppress sales are reductions in the mortgage interest deduction and the elimination of the state and local tax (“SALT”) deduction. And while significant differences exist between the two versions of the Bill, both bills as they currently stand could remake the housing market.

Changes to the Mortgage Interest Deduction

The first change that could impact housing prices is the mortgage interest deduction. Currently homeowners are allowed to lower their taxable income by excluding the interest they pay on a mortgage up to a $1 million dollar mortgage. The House and Senate versions of the Bill have noticeable differences on how they treat the mortgage interest deduction and the Bill’s impact on housing prices.

The House Bill is much more drastic and would limit the mortgage interest deduction to the first $500,000 of a loan, halving the current deduction limit. In many housing markets this might not have a large impact, but in markets where many homes sell for far north of $500,000 the impact could be widely felt.

A home buyer borrowing $1 million dollars for their new home purchase at a 4% interest rate would currently be able to exclude $40,000 of their income from taxable income. Although the amount this saves the home buyer is contingent on a number of things, if that buyer’s effective tax rate is 35% he might end up saving $14,000 he would otherwise owe in taxes.

With the House’s Bill he would be eligible only to exclude the interest paid on the first $500,000, or $20,000 worth of interest in this scenario, resulting in a mortgage interest deduction that likely saved him around $7,000 in taxes. A homebuyer expecting to save $7k a year in taxes may well need to lower the amount he needs to repay on his mortgage by $580 a month. At the same 4% interest rate as the scenario above, this means finding a home that is $120,000 cheaper. That million dollar mortgage today may need to be $880,000 in the future.

The Senate Bill does less to alter the mortgage interest deduction, but other changes make the mortgage interest deduction less attractive to taxpayers and may ultimately drive down homeownership more than the House’s version of the Bill. The Senate’s version of the Bill would leave the $1 million dollar threshold unchanged. Today and in the future homeowners who desire to take advantage of the mortgage interest deduction must itemize their taxes rather than take the standard deduction.

In 2017 the standard deduction for married couples is $12,700 ($6,350 for a single person). When married taxpayers opt to use the standard deduction, rather than itemize, $12,700 of their income is excluded from taxes. The Senate’s version of the bill would nearly double that amount to $24,000 for married couples ($12,000 for singles). If the effective tax rate that the couple pays is 35%, as in the example above, they are currently saving $4,200 that they would owe the IRS. Under the Senate’s Bill that couple would now be saving $8,400 that they would owe the IRS.

If those same taxpayers were deciding whether purchasing a home fit into their financial planning, they would now have to question whether the mortgage interest deduction on their property, plus other itemizations, would exclude more than $24,000 of their income. For simplicity’s sake, assuming the taxpayers have no other itemizations this means that in order to exclude more than the standard deduction, those same purchaser as the one above borrowing at 4% may only save money though itemization if their mortgage is over $600k.

Otherwise the taxpayers may be better off using the standard deduction. Under the current law those taxpayers borrowing at the same 4% interest rate and having no other itemizations would be save money through the mortgage interest deduction instead of the standard deduction if their mortgage is greater than $317,500. Ultimately the Senate’s Bill might make homeownership less attractive since the mortgage interest deduction is no longer the boon to homeowners it is today, particularly in markets where the median home price is considerably lower than the $600,000.

Either version of the Bill would result in a new calculation for determining the amount homeowners can afford and whether homeownership is the right path for those taxpayers.

And homeowners thinking about the advantages of the mortgage interest deduction on home equity loans need think no more: both the House and Senate would repeal the deduction for home equity loans, making them a far less attractive option than they currently are.

State and Local Tax (SALT) Deduction

Perhaps even more concerning to many would-be homeowners is the elimination of the State and Local Tax (SALT) Deduction. Under current tax law the state income tax and property taxes that a filer pays are deductible from Federal income tax. A person making $100,000 a year in salary and paying $8000 in state income tax and $2000 in local property taxes might currently be able to exclude $10,000 from Federal income taxes. Since both the House and Senate versions of the Bill would ultimately eliminate these deductions, that taxpayer, assuming an effective tax rate of 28%, is likely is to owe an additional $2,800. And while the elimination of the state income tax deduction might mean less money to spend on a new home, many would-be buyers will need to do some recalculations when considering a purchase in an area with high property taxes.

Take for instance the suburbs of New York City. Westchester County had a median property tax bill of $13,842 in 2015. At the 28% effective tax rate the taxpayer would find himself owing $3,875 more in Federal income tax each year. A homebuyer in Westchester County would now have to consider whether he can afford less home (at a 4% interest rate the borrower might need to purchase a home for $100,000 less to make up for nearly $4,000 a year owed following the elimination of SALT).

Overall Impact

It is still too soon to know what impact the 2017 Tax and Jobs Act will have on the mortgage industry, but the current iterations of both versions of the Bill may reduce the advantages of homeownership. This is a fundamental shift from a tax code that has long existed to subsidize the “American Dream” of homeownership and its ramifications could be far and wide.

***DISCLAIMER: For informational purposes only. Nothing in this post should be taken as tax advice. We are not tax experts and this analysis is our opinion of the current versions of Bill. As there is no final version of the bill much of this information is subject to change.