Who Benefits from Mortgage Deductions?

The Tax Reform Act of 1986 ended personal deductions for interest on credit card debt and other types of loans, but continued the home mortgage interest deduction, a popular tax expenditure. Supporters claim it makes home ownership more affordable for low- and middle-income families. Critics argue it subsidizes high-income earners who would have bought homes even without the tax advantages. How do different income groups benefit from this and other mortgage-related deductions? And could these tax incentives be structured to better achieve their objectives?

Types of Mortgage Deductions. Most mortgage-related tax deductions are for interest paid on a home loan. But homebuyers are also eligible to deduct payments for points. Borrowers purchase points for each 1 percent of their loan balance they pay at closing in addition to the down payment, typically in exchange for a 0.25 percent reduction in their interest rate. For example, a homebuyer taking out a $300,000 mortgage with an interest rate of 4.25 percent could pay an additional $3,000 at closing and the lender would lower the interest rate to 4 percent.

In addition, unlike homeowner’s insurance, borrowers can deduct payments for the private mortgage insurance (PMI) they are required to purchase if their down payment is less than 20 percent of the home value. PMI protects lenders if borrowers default, but it is not required after a homeowner reaches 20 percent equity, either through appreciation of the home or by paying down the loan balance. Congress made PMI payments deductible in 2007 to boost the housing market, but must reauthorize this tax break annually.

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