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NEW YORK (
TheStreet) -- The headline in Monday's
New York Times was enough to chill anyone with a mortgage: "Mortgage Interest Deduction, Once a Sacred Cow, Is Under Scrutiny."
The story went on to say that Congress and the White House are considering ways to trim this cherished deduction as a way to
raise billions. Would this make homeownership less desirable?
In some cases yes, though owning would most likely continue to be
better financially than renting, at least for people who plan to stay put for a number of years. But before panicking, homeowners -- and those who wish to join them -- should take a reality check. Trimming this deduction might not be as bad as you think.
First of all, this may never happen. Homeowners have lots of friends in Washington, and Congress could face a voter rebellion if it cut too deeply into a tax benefit many see as a sacred right.
Second, most news reports suggest the most likely cut, if there were any, would affect only wealthier households. President Barack Obama and both Democratic and Republican members of Congress generally agree there should be no tax increases for households earning less than $250,000 (or $200,000 for singles).
Trimming the interest deduction might involve a cap on deductions for affluent households, or eliminating the deduction on
second homes. Currently, interest payments on up to $1 million in mortgage debt can be deducted, even if some of it is on a second home.
But even more significant, the current deduction is
not as valuable as many people think. Obviously, it's available only to homeowners who have a mortgage, and about of third of homeowners, including many seniors, own their homes free and clear.
Also, the deduction becomes less valuable over time, because as a mortgage balance is paid down, a smaller and smaller portion of the monthly payment goes to interest. With less interest to subtract from your income, the tax saving is smaller.
Finally, the deduction is available only to homeowners who itemize deductions on their federal tax returns, and tens of millions of homeowners do not. This is where the matter gets a bit complicated.
Smart taxpayers itemize only if itemized deductions total more than what they can claim with the "standard deduction" that is available only to taxpayers who do not itemize. Over the years, the standard deduction has become quite large. For this year it is $11,900 for married couples filing joint returns, $5,950 for singles. Like itemized deductions, the standard deduction is subtracted from taxable income, and you can take one or the other, but not both.
That means a couple's itemized deductions -- mortgage interest, gifts to charity, medical expenses and so forth -- must total more than $11,900 or it would make more sense to take the standard deduction.
It also means that the only true savings produced by itemized deductions is on the portion that exceeds the standard deduction. If a couple's only itemized deduction were $15,000 in mortgage interest, the mortgage would add only $3,100 to the deductible income -- the amount exceeding the $11,900 available on the standard deduction. If this couple were in the 15% tax bracket, the mortgage deduction would save them just $465, not $2,250 (15% of $15,000).
Of course, any deduction's value also depends on one's tax bracket. If you were in the top 35% bracket, deducting $1,000 would save you $350 in taxes. But you'd save only $150 if you were in the 15% bracket.
So Washington does bear watching, as there's no doubt trimming the mortgage deduction could be expensive for some homeowners, especially those with big mortgages and high tax brackets. But it seems unlikely that modest changes in the law would be devastating for the average homeowner.