The Mortgage Mistake?

In this article The Mortgage Mistake from a recent issue of The New Yorker, sent to me by fellow Harborside Sotheby’s agent, Joe McKane, the writer argues that incentives to encourage home ownership – including subsidized mortgage rates and tax deduction of mortgage interest – do little to increase the number of homeowners. Other Western countries have similar rates of home ownership without the same range of incentives.

Almost all the economic benefits of the mortgage deduction go to people earning more than $100,000 a year. Result: people overinvest in housing and underinvest in other types of asset. And because people tend to invest more in housing when the economy is doing well and less when it is doing poorly, housing tends to amplify the economy’s ups and downs.

The trigger for this article is the new 3% down mortgage offered by Fannie Mae and Freddie Mac for first-time home buyers (see my recent 3% down mortgages are back post.) Default rates for mortgages with down payments of 3-10% are almost 50% higher than for those with down payment above 10%. Thus, the New Yorker writer argues, while the new mortgages may turn more low-income people into homeowners, it will also likely increase the default rate.

Two questions come to my mind: is increased home ownership an unarguably good thing? And does mortgage interest deduction encourage home ownership?

In answer to the first question the Center for Economic and Policy Research says: “low- and moderate-income households have less stable jobs, less stable family situations, and are more likely to have to move, which means that many of them are not going to own a home long enough to be able to recover their original investment.” In other words, home ownership is not appropriate for many people. And that applies not only to “low- and moderate-income ” people. Last summer I met a highly paid executive moving from the West Coast to the East Coast who was planning to rent because she was uncertain as to how long she would stay here.

Twenty or thirty years ago, the American Dream consisted of a college degree and a career spent probably with one or two companies. Once established, such people married, had children and bought a house. My how the world has changed! I read recently that the average person in his or her 30s today has had 9 jobs. There is an argument that home ownership for young people today could be an impediment when it comes to career options. As many million people have discovered in recent years, if you can’t sell your house you can’t move to a new job in a new area.

And what about the Baby Boomers? I suspect some of us will feel we have had enough of home maintenance and decide to rent, freeing up capital for adventures like travel.

Clearly, there are many people for whom home ownership is not appropriate. And just as clearly there have been many people over the years who would have made good home owners but have been unable to qualify for one reason or another.

Just as in education and so many other fields, I believe the key is to provide as many people as possible with the opportunity to become a homeowner. But it is harder today than say 20 years ago to state unequivocally that increased home ownership is an appropriate goal.

And what about those deductions? I grew up in the UK. The following table shows the mortgage amount on which interest was deductible. When the 30,000 limit was introduced in 1983 (to squeals of protest) it was in line with the median house price. When tax relief was abolished in 1999, 2/3 of mortgages were above the limit. What has been the impact on house prices? Well, I sold my house in London in 1997 and I recently had an estimate that it was now worth more than 5 times the price at which I sold it!

Source: Journal of Housing Research, Fannie Mae Foundation

Here in the US, according to this  Mortgage Interest Deduction is Ripe for Reform report, the following table shows who actually benefits from the deduction:

Furthermore,” close to half of homeowners with mortgages — most of them middle- and lower-income families — receive no benefit from the deduction.”

Will there be a change?
Well Congress has been debating the future of Fannie Mae and Freddie Mac since 2008. Whether the buyers of mortgages should be public or private companies is hardly a topic that will engage the attention of most Americans. But changing mortgage tax deduction certainly will! In 2014 House Ways and Means Committee Chair Dave Camp (R) proposed lowering the principal cap over several years from $1 million to $500,000. And the Democrats may well focus on inequality as they regroup after their recent losses.

Having seen what has happened in other countries and in other areas of the tax code, it would not be a surprise if changes were made to the mortgage tax deduction, with such changes factored in over time.  But as other countries have shown, this will not necessarily lead to lower housing prices.

If you – or somebody you know – are considering buying or selling a home and have questions about the market and/or current home prices, feel free to contact me on 617.834.8205 or Andrew.Oliver@SothebysRealty.com.

Andrew Oliver is a Realtor with Harborside Sotheby’s International Realty Sotheby’s International Realty® is a registered trademark licensed to Sotheby’s International Realty Affiliates LLC. Each Office Is Independently Owned and Operated

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