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TheStreet Open House

Housing Recovery, Homeowners Being Dragged to Fiscal Cliff

NEW YORK ( TheStreet) -- For most of us, the fiscal cliff is about two things: raising taxes and cutting government spending. But it poses issues closer to home, too -- literally. Homeowners could see their costs go up with the loss of benefits such as the cherished mortgage interest deduction.

That's one of several home-related implications of addressing the fiscal cliff, which entails a range of federal budgetary and tax issues if Washington doesn't find an alternative by early in the New Year, according to an assessment by HSH.com, the mortgage-data firm. The cliff involves spending cuts resulting from the debt ceiling showdown last year, coupled with the expiration of Bush-era tax cuts.

While there have been signs in recent days Democrats and Republicans might reach a compromise, they are still far apart. HSH warns that going over the cliff could pull the rug out from under the housing recovery, which has been strengthening in recent months.

Various proposals would cut or eliminate the mortgage interest deduction, which allows homeowners to subtract their mortgage interest payments from their income, reducing their income taxes. Currently, interest can be deducted on loans up to $1 million for first and second homes.

"I believe the deduction won't be eliminated, but scaled back to coincide with the current conforming loan limits for high-cost areas," HSH Vice President Keith Gumbinger says. "So rather than a million-dollar maximum limit, the total might be scaled back to $625,000, for example. Interest accrued on mortgage debt in excess of that figure would no longer be deductible."

Also in jeopardy is a tax break that expires Dec. 31 for short sellers, or homeowners who get their lenders to forgive the remaining debt after selling their homes for less then they owe. If the law, enacted during the financial crisis, expires, the old rules will return and the forgiven amount will be counted as taxable income. HSH warns this could reduce the number of short sales, which allow "underwater" homeowners to get free of their mortgages. That could slow the housing recovery, which could weaken home price gains for other homeowners as well.

A tax deduction on mortgage insurance is also set to expire at the end of this year. Mortgage insurance is generally required of borrowers who make down payments of less than 20%. It can be canceled once the equity exceeds 20%, which normally happens after a few years of appreciation. But the collapse in home prices a few years go left many homeowners far short of 20% equity, so eliminating the insurance deduction could raise costs for millions.

HSH also notes that the Federal Reserve's Operation Twist is scheduled to wind down by the end of the year, possibly causing mortgage rates to rise. This program involves selling short-term securities and using the proceeds to buy long-term ones to drive down long-term interest rates.

All these issues put homeowners and prospective buyers in a tough position. As a buyer, for example, you might want to hurry to beat any possible hike in mortgage rates. Then again, you might want to wait to be sure your mortgage interest would be deductible.

It's a mess, and for now the only thing to do is to keep a sharp on the news.

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