Our readers are divided over how eliminating the mortgage interest tax deduction (MID) will impact home prices, according to our recent poll. Nearly half of voters — 45% — believe prices will decrease but eventually level out, while 42% think home prices will continue to decrease over time. Only 14% voted home prices will be unaffected by removing the MID.

Thus, while a combined 87% agree MID elimination will cause home prices to decrease, readers are undecided on the long-term pricing trajectory.

The MID’s inequitable benefits

The MID was enacted to encourage homeownership by subsidizing low- to middle-income homeowners through a tax deduction on interest paid on mortgages, called qualified interest. Mortgage interest is deductible from income as an itemized expense when the mortgage:

  • funded the purchase price or paid for the cost of improvements to the owner’s principal residence or second home; and
  • is secured by either the owner’s principal residence or second home. [Internal Revenue Code §163(h)]

Proponents in the real estate industry hold the MID in high esteem, claiming it is a critical tax law that achieves its goal of ensuring the affordability of homes.

However, despite the MID’s largely positive reputation, the tax law has been known to disproportionately benefit high-income homeowners, sellers and lenders, rather than the low- and middle-income homeowners it was meant to assist. Further, the MID has been shown to contribute to income inequality, as it favors and is primarily claimed by wealthy homeowners.

How does the MID disproportionately benefit wealthy homeowners, sellers and lenders?

First, claiming the MID requires a homeowner to itemize their deductions — a type of tax filing used only when the homeowner’s income and total deductions are high enough to outweigh the benefits of claiming a standard deduction. Low- and middle-income homeowners whose incomes cannot support a larger mortgage amount typically do not itemize their deductions and, thus, lose out on the benefits of the MID.

The basic rule for the MID is: the wealthier the homeowner, the more home they purchase, the bigger the tax savings.

Second, the MID encourages homeowners to increase the mortgage amount they are willing to take on in the hopes of reducing their financial burden through a tax deduction. However, most of these homeowners never claim the deduction at all, instead passing the benefits onto lenders and sellers through inflated mortgage principals.

The MID and home prices

While the MID acts as a tax savings for the wealthy, it simultaneously baits homeowners to overextend their finances to replace the lost revenue. The MID thus inflates home prices, increasing the amounts both lenders and sellers receive on a sale.

Rather than acting as a tax subsidy for the average homeowner, the MID ultimately redistributes personal wealth via mortgaged homeownership. Homebuyers pay for the resulting price inflation through the purchase price of the home as profits go directly to sellers and lenders.

Curiously, though our poll results indicate readers are aware of this artificial price inflation — admitting elimination of the MID will cause a reduction in home prices — the majority of readers also voted in a separate poll that the MID does not drive up home prices, with only 42% agreeing the MID causes price inflation.

These conflicting poll results suggest some reader uncertainty about the pricing effects of the MID on the real estate market.

However, one thing is clear: the MID has significant sway among real estate professionals and homebuyers. Though the MID’s critical shortcomings disadvantage the average homeowner, prevailing support for the MID means it is unlikely to be eliminated from the tax code.

A more practical resolution is reform of the MID to redirect the benefits from wealthy beneficiaries to mid- and low-income homebuyers — the intended recipients of the MID benefits. Until then, the MID will continue to inflate profits for sellers and lenders, while low- and mid-income homebuyers pay the (home) price.

Related article:

The MID truth test