A tax break to encourage homeownership primarily helps the wealthy

Home prices in many parts of the country are at record highs, with a typical home costing more than a million dollars in more than 500 cities. With current interest rates, homeownership is increasingly challenging, especially for first-time buyers. 

For decades, some homeowners have relied on the home mortgage interest deduction to ease the financial burden of purchasing a home. This deduction is what’s known as a tax expenditure — a tax break the government uses to incentivize certain behaviors, such as homeownership.

“The mortgage interest deduction was introduced in the tax code really as a way to try to help with a goal of helping folks have a more attainable homeownership to try to reduce the net costs of entering into a mortgage,” said Garrett Watson, a senior policy analyst at the Tax Foundation. “But though it does reduce the cost for homeowners who do claim it, it does come with some trade-offs.”

For example, people can only take advantage of the mortgage interest deduction if they are among the 11% of taxpayers who itemize their tax returns, and the mortgage interest they pay is more than the standard deduction of just under $30,000 for married couples filing jointly this year.

“The average deduction usually goes to people earning [$100,000] to over $200,000 a year,” said Muhammad Alameldin, a policy associate at the Terner Center for Housing Innovation at the University of California, Berkeley. “For people earning over $200,000 a year, this reduces their taxes by $5,300. While people earning $100,000 or less see an average deduction of about $300.”

The 2017 Tax Cuts and Jobs Act changed how much of a mortgage is eligible for the interest deduction, dropping the upper limit from $1 million to $750,000. 

“But at these prices, they’re getting it, right?” said realtor Wendy Wright, with Keller Williams Metro Center in Virginia. Wright was setting out balloons and bottles of water to welcome potential buyers to a 5-bedroom, 5 1/2-bath home in Damascus, Maryland, about an hour outside of Washington, D.C. The home was listed at almost $900,000. Unless the buyer pays in cash, interest payments will make the house cost several times that over the life of a typical 30-year mortgage. This is the typical kind of home where the buyer could potentially claim the mortgage interest deduction.

But, points out Wright, “at higher interest rates, your interest on your mortgage is higher, hence, you’re probably taking more of a deduction at a lower price point because of the interest rate being higher. … And then if you think about it, a lot of the people that are buying at the lower price points may only be putting 3% down. So it’s still a lot of interest.” 

Still, the vast majority of people don’t benefit from the mortgage interest deduction, and many economists argue there’s not much evidence that the mortgage interest deduction encourages more people to buy homes instead of renting. Instead, there’s evidence it drives up home prices or incentivizes bigger homes.

Plus, said Garrett Watson at the Tax Foundation, there’s a cost to the federal government for all those deductions for big, expensive houses belonging primarily to higher-income people.

“It does have a revenue effect,” he said, “Every year about $30 billion. And if that deduction were pared back further or eliminated, that revenue could be used to lower rates elsewhere, or to grow and fund other priorities.” The current limit of $750,000 on the mortgage interest deduction is set to revert back to a million dollars at the end of 2025, when the Tax Cuts and Jobs Act expires. According to the Center on Budget and Policy Priorities, unless Congress takes action, that cost of the program will jump from about $30 billion a year to more than $80 billion a year.