As the federal government continues to grapple with the new reality that there are limitations on how much money our nation can borrow, we are starting to examine possible changes to the tax code, as well as how our tax dollars are spent. Topics that were previously taboo are now on the table.
One hot button that surfaced with President Obama's Debt Commission was the thought of reducing or eliminating the home mortgage deduction. For most homeowners, the ability to deduct mortgage interest is an important part of making home ownership affordable and remains one of the few tax breaks left for individuals. We thought this might be a good time to examine how the system of home mortgages has evolved over the years and what the future might hold.
The word mortgage comes from a combination of the Latin word "mort," meaning dead, and "gage," which equates with the Latin word "pignus," meaning collateral or pawn. When you put the two together, it means that your collateral (the house) is dead (or forfeited) if you don't pay the mortgage.
The concept of a home mortgage is actually based on old English law and was brought to this country by the Puritan settlers. But up until the 1930's, mortgages were rare. Most people would simply pay cash for a piece of property. Even as mortgages started to come onto the scene, they weren't much of a loan. Typically, you would be required to put 50 percent down and the balance would be paid over five years. It's a long way from the zero-down 30-year mortgages that helped fuel the recent housing boom.
Deducting your mortgage interest wasn't really an issue until the first federal income tax was created in 1894. However, the United States Supreme Court initially ruled that federal taxes were unconstitutional. So mortgage interest deductions didn't really come into play until 1913, when the Constitution was amended to allow for a federal tax. Nevertheless, few people other than farmers had mortgages, so it was inconsequential to the Federal government's revenue stream. The home mortgage deduction was just lumped in with all types of interest payments and expenses that were allowable deductions for both businesses and individuals.
The home mortgage interest deduction that we enjoy today has been in place for as long as we've had federal taxes. The only notable change in interest deductibility occurred with the Tax Reform Act of 1986. At that time, the interest deduction was eliminated on most all personal loans and credit cards. The mortgage interest deduction survived as part of an effort to promote home ownership. But people quickly circumvented the law with home equity loans as a way to still deduct the interest on borrowed money for personal purchases, such as a car. The Tax Reform Act of 1986 had the unintended consequence of encouraging people to borrow against the equity in their home. The subsequent reduction in overall equity rates no doubt worsened the impact of recent decline in home prices. For example, in Canada, where the tax laws regarding mortgage interest are different, the average debt carried on a home is much lower than levels found in the United States.
Although the mortgage interest deduction is likely to be much discussed as the government looks for new sources of revenue, to some extent, it's a bit of a red herring. Where the government really spends money on mortgages is with the effort to maintain liquidity in mortgage markets and help guarantee a plentiful pool of money for home loans. Here's what we mean.
In the beginning, a bank would make a home loan, and they would hold the loan until it was paid back. If the loan went bad, the bank would suffer a loss. Unfortunately, the Great Depression came along, and suddenly there were 1,000 foreclosures a day. Like today, this was causing banks to fail and mortgage money dried up. So, President Roosevelt created the Home Owners Loan Corporation. The HOLC was an attempt to stop the bleeding by allowing banks to exchange mortgages for government bonds. The Troubled Asset Relief Program of 2008 was, in many ways, similar to Roosevelt's HOLC of 1933.
Despite HOLC, liquidity was still a problem in the mortgage markets, so in 1934 the government created the Federal Housing Administration. The FHA provided mortgage insurance to lenders, and by reducing the risk to banks with federally backed insurance, the flow of money for home loans was improved.
Unfortunately, more was needed to keep the banks and borrowers alive. In 1938, as part of FDR's New Deal, the Federal National Mortgage Association, affectionately known as Fannie Mae, was born. This significantly increased government involvement with the process. Essentially, Fannie Mae created the secondary mortgage market, and the federal government took another huge step in further eliminating the bank's long-term risk, thus freeing up more capital for them to make new home loans.
Fannie Mae grew by leaps and bounds. In 1968, President Johnson privatized Fannie so he could remove it from the federal budget and create the illusion of an improved fiscal condition. Fannie Mae became what's known as a government-sponsored enterprise or GSE. Essentially this means that Fannie would operate as a private business, but enjoy the ongoing financial backing of the federal government. As if one of these GSEs wasn't bad enough, the evil twin Freddie Mac was created in 1970. Fannie and Freddie became the only two Fortune 500 companies allowed to operate without having to make the public financial disclosures required of other corporations.
The bubble was being inflated, and it finally burst when overly creative financial institutions completely derailed the system with casino style manipulation of mortgage securities, while politicians simultaneously stirred the pot by demanding that home ownership was a right to be granted, rather than a privilege to be earned. It was a perfect storm that tumbled an already fragile house of cards.
Recently, Fannie and Freddie have become a colossal financial failure, costing the American taxpayer billions. So, it became necessary to take yet another step in government backing of the mortgage markets. If buying loans from the banks wasn't proving enough to promote liquidity, then all that's left is to buy the banks. As the housing market collapsed, the federal bailout of many financial institutions basically accomplished just that. However, many of the banks quickly found that Uncle Sam was no fun to have as a partner. So, we're currently in the phase of undoing that drastic action.
The future of the mortgage interest rate deduction is probably still up for grabs. But, over the years, the real cost to the government isn't derived from interest deductions; rather, it comes from the need to make mortgage money available. The current value of the mortgage interest deductions is around $100 billion. That may be a whole lot of dough, but government subsidies of Freddie and Fannie have recently cost more than $135 billion, and there's also still the unknown cost of bailing out private financial institutions, as well as the expenses associated with what the Federal Reserve is doing to inject liquidity into the markets to keep interest rates low.
Last Thursday, in his speech before a joint session of Congress, President Obama alluded to possible federal help in allowing homeowners to refinance into lower interest loans. So, in a one-step-forward, one-step-back trip to nowhere, the government is simultaneously talking about increasing the cost of housing by reducing the mortgage interest deduction, while they also talk about helping homeowners by reducing their interest rates. Given the current focus on reviving the economy, changes to the home mortgage deduction will probably be shelved for now. But, after the elections in 2012, the mortgage interest deduction debate will likely resurface as part of overall tax code reform.
---
Bob and Donna McWilliams are practicing real estate agents with more than 20 years of combined experience in the Annapolis area. Their website is www.BobDonna.com, and you can e-mail them at McWilliams@BobDonna.com.
Source http://www.hometownannapolis.com/
One hot button that surfaced with President Obama's Debt Commission was the thought of reducing or eliminating the home mortgage deduction. For most homeowners, the ability to deduct mortgage interest is an important part of making home ownership affordable and remains one of the few tax breaks left for individuals. We thought this might be a good time to examine how the system of home mortgages has evolved over the years and what the future might hold.
The word mortgage comes from a combination of the Latin word "mort," meaning dead, and "gage," which equates with the Latin word "pignus," meaning collateral or pawn. When you put the two together, it means that your collateral (the house) is dead (or forfeited) if you don't pay the mortgage.
The concept of a home mortgage is actually based on old English law and was brought to this country by the Puritan settlers. But up until the 1930's, mortgages were rare. Most people would simply pay cash for a piece of property. Even as mortgages started to come onto the scene, they weren't much of a loan. Typically, you would be required to put 50 percent down and the balance would be paid over five years. It's a long way from the zero-down 30-year mortgages that helped fuel the recent housing boom.
Deducting your mortgage interest wasn't really an issue until the first federal income tax was created in 1894. However, the United States Supreme Court initially ruled that federal taxes were unconstitutional. So mortgage interest deductions didn't really come into play until 1913, when the Constitution was amended to allow for a federal tax. Nevertheless, few people other than farmers had mortgages, so it was inconsequential to the Federal government's revenue stream. The home mortgage deduction was just lumped in with all types of interest payments and expenses that were allowable deductions for both businesses and individuals.
The home mortgage interest deduction that we enjoy today has been in place for as long as we've had federal taxes. The only notable change in interest deductibility occurred with the Tax Reform Act of 1986. At that time, the interest deduction was eliminated on most all personal loans and credit cards. The mortgage interest deduction survived as part of an effort to promote home ownership. But people quickly circumvented the law with home equity loans as a way to still deduct the interest on borrowed money for personal purchases, such as a car. The Tax Reform Act of 1986 had the unintended consequence of encouraging people to borrow against the equity in their home. The subsequent reduction in overall equity rates no doubt worsened the impact of recent decline in home prices. For example, in Canada, where the tax laws regarding mortgage interest are different, the average debt carried on a home is much lower than levels found in the United States.
Although the mortgage interest deduction is likely to be much discussed as the government looks for new sources of revenue, to some extent, it's a bit of a red herring. Where the government really spends money on mortgages is with the effort to maintain liquidity in mortgage markets and help guarantee a plentiful pool of money for home loans. Here's what we mean.
In the beginning, a bank would make a home loan, and they would hold the loan until it was paid back. If the loan went bad, the bank would suffer a loss. Unfortunately, the Great Depression came along, and suddenly there were 1,000 foreclosures a day. Like today, this was causing banks to fail and mortgage money dried up. So, President Roosevelt created the Home Owners Loan Corporation. The HOLC was an attempt to stop the bleeding by allowing banks to exchange mortgages for government bonds. The Troubled Asset Relief Program of 2008 was, in many ways, similar to Roosevelt's HOLC of 1933.
Despite HOLC, liquidity was still a problem in the mortgage markets, so in 1934 the government created the Federal Housing Administration. The FHA provided mortgage insurance to lenders, and by reducing the risk to banks with federally backed insurance, the flow of money for home loans was improved.
Unfortunately, more was needed to keep the banks and borrowers alive. In 1938, as part of FDR's New Deal, the Federal National Mortgage Association, affectionately known as Fannie Mae, was born. This significantly increased government involvement with the process. Essentially, Fannie Mae created the secondary mortgage market, and the federal government took another huge step in further eliminating the bank's long-term risk, thus freeing up more capital for them to make new home loans.
Fannie Mae grew by leaps and bounds. In 1968, President Johnson privatized Fannie so he could remove it from the federal budget and create the illusion of an improved fiscal condition. Fannie Mae became what's known as a government-sponsored enterprise or GSE. Essentially this means that Fannie would operate as a private business, but enjoy the ongoing financial backing of the federal government. As if one of these GSEs wasn't bad enough, the evil twin Freddie Mac was created in 1970. Fannie and Freddie became the only two Fortune 500 companies allowed to operate without having to make the public financial disclosures required of other corporations.
The bubble was being inflated, and it finally burst when overly creative financial institutions completely derailed the system with casino style manipulation of mortgage securities, while politicians simultaneously stirred the pot by demanding that home ownership was a right to be granted, rather than a privilege to be earned. It was a perfect storm that tumbled an already fragile house of cards.
Recently, Fannie and Freddie have become a colossal financial failure, costing the American taxpayer billions. So, it became necessary to take yet another step in government backing of the mortgage markets. If buying loans from the banks wasn't proving enough to promote liquidity, then all that's left is to buy the banks. As the housing market collapsed, the federal bailout of many financial institutions basically accomplished just that. However, many of the banks quickly found that Uncle Sam was no fun to have as a partner. So, we're currently in the phase of undoing that drastic action.
The future of the mortgage interest rate deduction is probably still up for grabs. But, over the years, the real cost to the government isn't derived from interest deductions; rather, it comes from the need to make mortgage money available. The current value of the mortgage interest deductions is around $100 billion. That may be a whole lot of dough, but government subsidies of Freddie and Fannie have recently cost more than $135 billion, and there's also still the unknown cost of bailing out private financial institutions, as well as the expenses associated with what the Federal Reserve is doing to inject liquidity into the markets to keep interest rates low.
Last Thursday, in his speech before a joint session of Congress, President Obama alluded to possible federal help in allowing homeowners to refinance into lower interest loans. So, in a one-step-forward, one-step-back trip to nowhere, the government is simultaneously talking about increasing the cost of housing by reducing the mortgage interest deduction, while they also talk about helping homeowners by reducing their interest rates. Given the current focus on reviving the economy, changes to the home mortgage deduction will probably be shelved for now. But, after the elections in 2012, the mortgage interest deduction debate will likely resurface as part of overall tax code reform.
---
Bob and Donna McWilliams are practicing real estate agents with more than 20 years of combined experience in the Annapolis area. Their website is www.BobDonna.com, and you can e-mail them at McWilliams@BobDonna.com.
Source http://www.hometownannapolis.com/
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