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What Effect Will the Fiscal Cliff Have on Home Prices?

What Effect Will the Fiscal Cliff Have on Home Prices?Unless Congress and the Obama administration come to an agreement before January 1, 2013, automatic spending cuts and the expiration of tax cuts will kick in, pushing the economy off the so-called “fiscal cliff,” a term coined by Federal Reserve Chairman Ben Bernanke in February. This means for most Americans taxes would go up and at the same time government spending would drop sharply, which would reduce the deficit but could trigger another recession.

As Congress and the White House look for ways to increase revenue to avoid this from happening, some proposals include reducing or eliminating the mortgage interest deduction for homeowners. According to an article in Banker and Tradesman this month, the mortgage interest and property tax deductions cost the Treasury over $110 billion. However, analysts worry that scaling back on the mortgage interest deduction might hurt the still-fragile housing market.

How will home values be affected if we lose real estate deductions for mortgage interest and property taxes? In an article in Realtor®Mag, Lawrence Yun, chief economist at the National Association of Realtors® (NAR), said the reduction or elimination of the mortgage interest deduction could cause home values to plummet 15%.

A 2010 study performed by the Tax Policy Center, The Effect of Proposed Tax Reforms on Metropolitan Housing Prices, looked at the effect limiting mortgage interest deduction and property tax deductions would have on home prices. The study looked at two of President Obama’s proposals from 2011. In one scenario in the study, when taxpayers in the 33 percent bracket had their mortgage interest deductions limited to 28 percent, housing values declined by 6.9 percent to 15 percent. In another scenario when taxpayers in the 35 percent bracket had their mortgage interest deductions limited to 28 percent, housing values dropped by 9.3 to 19.6 percent.

Just as the housing market is starting to show signs of recovery, reducing the mortgage interest deduction could slow it down again. Potential home owners expect this deduction and figure this into how much they borrow. A summary released by the National Association of Home Builders (NAHB) in March says a typical homeowner with $54,000 in taxable income saves an average $7,500 during the first five years of homeownership. This is money that is often spent on living expenses, home improvements, and other items that actually help stimulate the economy.

The mortgage interest deduction is also important for people who own a second home. According to statistics from the NAHB, there are 6.9 million homes that qualify as non-rental second homes (more than 5% of all housing units in the U.S.). Here in Massachusetts homeowners who own vacation homes on Cape Cod would be affected by a change in the mortgage interest deduction. Without the deduction, fewer people would purchase vacation homes on Cape Cod which would directly affect the economy in the region. Vacation home sales in Cape Cod contribute to home goods sales, putting construction workers to work on home improvements, and increased revenue for local restaurants and services. In October 2012, home sales in Barnstable County increased 22% compared to October 2011. Just as the housing market is showing signs of improvement, the Cape Cod economy should not lose this important incentive to purchase vacation homes as well as primary residences.

The mortgage interest deduction affects everyone, even those who don’t yet own a home. When home values decline, so do tax revenues for entire communities. The mortgage interest deduction is vital to our economy and should remain intact. We fully support keeping the mortgage interest deduction at a time when the housing market is just starting to improve. If potential home buyers can’t take advantage of the mortgage interest deduction and at the same time experience an increase in their taxes, they may not look to purchase a home at all.