April 26, 2017 in Mortgages

The mortgage interest deduction would survive under President Donald Trump’s tax reform plan. But fewer homeowners would use it.

The reason is that the standard deduction would be almost doubled, leaving the mortgage interest deduction only for homeowners who pay the most interest. Those are the people with the biggest home loans.

What you can do

Tax reform will take a long, convoluted path through Congress. Any bill that is signed into law will differ from what was proposed originally. If the expanded standard deduction makes it through, you’ll probably pay less taxes overall, but without using the mortgage interest deduction. Steps to take:

  • If you plan to buy your first home within a few years, consider saving up for a bigger down payment. If you’re not going to deduct your mortgage interest, you will benefit from having a smaller mortgage and thus paying less interest.
  • If you own a home, consider getting a home equity line of credit before tax reform passes. Your home’s value could fall in the future, reducing the equity to borrow from. So you might be able to get a bigger credit line now than you will after tax reform is passed.
  • If you file jointly and deduct more than $24,000 a year, cheer up — you might get to keep deducting mortgage interest, depending on the details of the tax reform that’s eventually passed. Shop for a jumbo mortgage if you’re a big earner.

A simpler tax code?

The fate of the mortgage interest deduction will be debated this spring and summer as Congress and the president wrestle with tax reform.

Treasury Secretary Steve Mnuchin presented the outline — “a broad-brush view,” he said — of a tax plan that would retain the mortgage interest deduction, but decrease the number of homeowners who would take it. Most homeowners would see a reduction in their tax bill, even without deducting mortgage interest, handing them more money to put into savings.

All about the deductions

For middle-class homeowners, the main points of the Trump administration’s proposal are:

  • A reduction in the number of tax brackets, from seven to three.
  • Tax brackets of 10 percent, 25 percent and 35 percent.
  • Elimination of the deduction for state and local income taxes.
  • A big increase in the standard deduction, to $24,000 for joint filers from the current $12,600. Single filers would have a $12,000 standard deduction, up from $6,300.

That last item, the bigger standard deduction, would mean that millions of homeowners would stop using the mortgage interest deduction. In return, they would end up in lower tax brackets, resulting in savings.

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Fewer would itemize

Fewer people would use the mortgage interest deduction because of the way itemization works. You file Schedule A when total itemized deductions exceed the standard deduction. For example, if a single taxpayer’s mortgage interest and charitable contributions totaled $10,000 in 2016, he or she itemized — because those costs exceeded the $6,300 standard deduction. Bring on Schedule A!

But if the standard deduction were raised to $12,000 for the same taxpayer, he or she would claim the standard deduction because that’s more than the $10,000 in mortgage interest and charitable contributions.

Trump campaigned on a plan to increase the standard deduction even more — to $30,000 for joint filers and $15,000 for singles. The nonpartisan Urban-Brookings Tax Policy Center estimated that that plan would have reduced itemizers by 60 percent, from 45 million to 18 million. “Even under current law, about three-quarters of tax filers take the standard deduction and would be exempt from a cap on itemized deductions,” writes the center’s Howard Gleckman.

Lower home values

Home values could fall in response to a lessening of the value of the mortgage interest deduction. In a paper published last year, Federal Reserve economist David E. Rappoport calculated that house prices would fall an average of 6.9 percent if the mortgage interest deduction were eliminated.

Rappoport didn’t estimate the effect on home values if the mortgage interest deduction were to remain, but useful to fewer people. He did point out that a drop in house prices would allow first-time homebuyers to pay less for their homes. That could mean more people could afford to buy homes and get mortgages.

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