The Mortgage Interest Deduction

The Mortgage Interest Deduction

May 7, 2020
The Mortgage Interest Deduction
The mortgage interest deduction is of interest to
For purposes of the deduction, mortgage debt includes
policymakers due to its association with homeownership.
home equity loans secured by a principal or second
The mortgage interest deduction is also of interest because
residence that are used to buy, build, or substantially
it is one of the largest tax benefits available to homeowners
improve a taxpayer’s home. Mortgage debt does not include
in terms of forgone federal tax revenue. For 2020, the Joint
home equity loans when the proceeds are used for purposes
Committee on Taxation (JCT) estimates that the deduction
unrelated to the property securing the loan. For example,
will reduce revenues by $30.2 billion. The only larger
interest associated with a home equity loan that is used to
housing-related tax expenditure is the exclusion for capital
pay off a credit card balance, go on a vacation, or send a
gains on the sale of a principal residence at a revenue cost
child to college does not qualify for the mortgage interest
of $35.9 billion in 2020. This In Focus provides a brief
deduction. The restrictions on the use of home equity loans
overview of the mortgage interest deduction.
apply irrespective of when the loan was originated.
P.L. 115-97, often referred to as the Tax Cuts and Jobs Act
After 2025, the mortgage interest deduction will revert to
(TCJA), changed the tax treatment of mortgage interest
the law that existed prior to TCJA.
starting in tax year 2018. Although the mortgage interest
deduction is still generally available, TCJA reduced the
Comparison to Prior Law
maximum mortgage balance eligible for the deduction and
Under prior law, a homeowner was allowed an itemized
restricted the deduction of interest associated with home
deduction for the interest paid on the first $1 million of
equity loans. TCJA also increased the standard deduction,
combined mortgage debt associated with a primary or
which reduced the number of taxpayers who claim itemized
secondary residence. As with current law, a homeowner
deductions generally, including for mortgage interest.
could deduct a percentage of interest paid if the mortgage
balance exceeded the $1 million limit. Additionally, a
Summary of Current Law
homeowner was allowed to deduct the interest on the first
A taxpayer may claim an itemized deduction for “qualified
$100,000 of home equity debt regardless of whether or not
residence interest,” which includes interest paid on a
the taxpayer incurred the debt to finance costs associated
mortgage secured by a principal residence and a second
with the home. For example, under prior law, a homeowner
residence. The amount of interest that is deductible depends
could use a home equity loan to purchase a boat, pay for a
on when the mortgage debt was incurred. For mortgage
child’s college, cover medical costs, or any number of other
debt incurred on or before December 15, 2017, the
things not involving the property that secured the loan and
combined mortgage limit is $1 million ($500,000 for
still deduct the associated interest.
married filing separately). For mortgage debt incurred after
December 15, 2017, the deduction is limited to the interest
Impact of TCJA
incurred on the first $750,000 ($375,000 for married filing
separately) of combined mortgage debt.
Impact on Homeowners
The reduced mortgage limits under TCJA decrease the
If a taxpayer has mortgage debt exceeding the applicable
amount of interest that would otherwise be deducted under
mortgage limit ($750,000 or $1 million), he or she may still
prior law, though the reduction itself will likely not have a
claim a deduction for a percentage of interest paid equal to
significant impact on the number of homeowners claiming
the applicable mortgage limit divided by the remaining
the deduction. However, other changes enacted by TCJA,
mortgage balance. For example, a homeowner whose
specifically the near doubling of the standard deduction and
mortgage was originated after December 15, 2017, and has
the $10,000 limit placed on the deduction for state and local
a balance of $1 million could deduct 75% ($750,000
income taxes (SALT), are estimated to have reduced the
divided by $1 million) of the interest payments.
itemization rate generally, and will therefore reduce the
number of homeowners claiming the mortgage interest
Refinanced mortgage debt is treated as having been
deduction. Shortly after enactment, the Tax Policy Center
incurred on the origination date of the original mortgage for
estimated that TCJA would reduce the overall itemization
purposes of determining which mortgage limit applies
rate from 26.4% of taxpayers to 10.9%. Because taxpayers
($750,000 or $1 million). The balance of the new loan
must itemize to claim the mortgage interest deduction,
resulting from the refinance, however, may not exceed the
fewer homeowners now benefit from the deduction.
balance of the original loan. This may occur, for example,
when a homeowner “cashes out” equity in the home by
The lower itemization rate and the fact that higher-income
obtaining a larger loan than is necessary to pay off the
homeowners have larger mortgage balances on average
current mortgage balance.
means that the benefits of the mortgage interest deduction
disproportionately accrue to taxpayers at the upper end of
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link to page 2 The Mortgage Interest Deduction
the income distribution (see Table 1), and more
recent line-item tax expenditure estimates, reflect not only
disproportionately than under prior law. This does not
the temporary reduction in the combined mortgage amount,
necessarily mean that homeowners who no longer claim the
but also the revenue effects from increasing the standard
mortgage interest deduction will pay higher taxes because
deduction and modifying a number of other itemized
the standard deduction and other changes enacted by TCJA
deductions, which is expected to significantly reduce the
may more than compensate for the loss of the deduction.
itemization rate. Still, as noted previously, the JCT
estimates that the new limits will reduce revenues by $30.2
Table 1. Distribution of Mortgage Interest Deduction
billion in 2020. In comparison, the JCT estimated that the
Tax Expenditure by Income Class, 2018
deduction was expected to generate a revenue loss of $66.4
billion in 2017 under prior law.
Share of
Share of Tax
Income Class
Claimants
Expenditure
Policy Considerations
Below $30k
0.6%
0.1%
The TCJA’s temporary modifications to the mortgage
interest deduction limits—as well as the standard deduction
$30k to $40k
0.9%
0.2%
and other itemized deductions—are scheduled to expire
$40k to $50k
1.5%
0.4%
after 2025, barring further congressional action. In addition
to extending these temporary changes or allowing them to
$50k to $75k
8.6%
2.7%
expire, Congress could choose to pursue a number of other
options that have been part of the debate over the mortgage
$75k to $100k
12.0%
5.8%
interest deduction.
$100k to $200k
39.0%
26.8%
Eliminate the Deduction
$200k and over
37.3%
63.9%
One possible option would be to eliminate the mortgage
Total
100%
100%
interest deduction, either abruptly or gradually over time.
Gradually phasing out the deduction could mitigate any
Source: CRS calculations using estimates reported in U.S. Congress,
negative consequences for the economy and housing
Joint Committee on Taxation, Estimates of Federal Tax Expenditures for
market. For example, the deduction could be phased out
Fiscal Years 2019-2023, 116th Cong., 1st sess., December 18, 2019,
over a 20-year period with a fixed date after which it would
JCX-55-19.
no longer be available. Current owners could deduct
interest for 20 years. Those who become new owners next
Although more homeowners claimed the mortgage interest
year could deduct interest for 19 years, and so on.
deduction before TCJA, it is important to note that less than
half of homeowners claimed the deduction prior to TCJA.
Further Limit the Deduction
This is because some homeowners have no mortgage, and
Continuing in the same direction as the TCJA, the
hence no interest to deduct. Others claimed the standard
deduction could be further limited. One option would be to
deduction because they were toward the end of their
reduce the combined maximum mortgage limit. The ability
mortgage repayment period and interest payments were a
to deduct interest on second homes could also be
small proportion of their total mortgage payment, they lived
eliminated. Another option would be to leave the combined
in a state with low state and local taxes, or they lived in a
mortgage limits unchanged, but limit the amount of interest
low-cost area and therefore had relatively small mortgages.
that could be deducted. For example, the amount of interest
that could be deducted could be limited to a percentage of
The effect on the homeownership rate from the changes
homeowners’ adjusted gross income (AGI), such as 10%,
enacted by TCJA is likely to be small even though fewer
12%, or 22%. The deduction could also be limited to those
homeowners will benefit from the deduction. The economic
homeowners below a certain income threshold.
literature has generally found that the deduction’s structure
prior to TCJA did little to promote homeownership,
Replace the Deduction with a Credit
because the deduction does not address the largest barriers
The mortgage interest deduction could be replaced with a
to homeownership—the down payment required by banks
tax credit. The deduction currently tends to provide a
and closing costs. Because the TCJA did not change the
proportionally bigger benefit to higher-income homeowners
deduction’s fundamental structure, the analysis of the
because they buy more expensive homes and are subject to
deduction’s effect on homeownership remains unchanged.
higher marginal tax rates. The requirement that
The TCJA changes’ impact could appear in slightly lower
homeowners itemize their tax returns also limits the number
home values, as the literature suggests that the deduction is
of owners who receive the tax benefit. A tax credit for
partly capitalized into home prices, though the impact may
mortgage interest could provide a benefit to more
be difficult to measure empirically.
homeowners because itemization would no longer be
required. Depending on the design of the credit, it could
Budgetary Impact
create a more consistent rate of subsidization across
The TCJA limits on the mortgage interest deduction are
homeowners. Making the tax credit refundable would serve
expected to increase federal tax revenues through 2025
to make it better targeted to lower-income homeowners.
relative to prior law. However, the JCT’s revenue estimates
do not isolate the revenue effects stemming from the
changes to the mortgage interest deduction. Estimates
Mark P. Keightley, Specialist in Economics
published while the TCJA was being considered, and more
IF11540
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The Mortgage Interest Deduction

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