Capping Mortgage Interest Deduction to $500,000; What Does It Mean?

The GOP’s tax bill has a provision to cap the mortgage interest deduction to loan amounts of $500,000 or less. To be clear, borrowers will not be ineligible for the mortgage interest deduction if they owe more than $500,000; borrowers will only be able to deduct interest that accrues against $500,000 of their mortgage, no matter how large it is.

Numerous people have asked us for our take on this and we have held off on saying anything b/c the bill is merely a proposal at this point, and not even close to passing. Here are a few observations in any case.

1. Only 5% of all mortgages are over $500,000. And the vast majority of them are in California. Hence, it is unlikely that we Californians will get a lot of sympathy from middle America. But this also explains why there is so much concern in California.

2. How much will it actually hurt borrowers? For a $1 million home (not a lot in coastal California) with 20% down, a borrower will have an $800,000 mortgage. This means that $300,000 of that debt will be ineligible for the mortgage interest tax deduction. If the interest rate is 4%, the borrower will not be able to deduct $12,000 of interest from his or her income for tax purposes. If that same borrower is in a 40.5% combined tax bracket (33% Federal, and 7.5% State), he or she will lose $4,860 in direct tax savings. That is real money for anyone.

3. Grandfathering existing mortgages. Current borrowers will be grandfathered, meaning they will be able to continue to deduct interest against a $1 million mortgage (or $1.1 million if they have an equity line). This provision will likely hurt inventory, as this will create another disincentive to sell.

4. Standard Deduction Doubling. This is the bigger issue for real estate in general, as most lenders and Realtors aggressively sell the tax benefits from buying a house. If the Standard Deduction for married couples doubles to $24,000, most taxpayers will not be eligible to take advantage of the mortgage interest deduction (it would only make sense if their mortgage interest and other itemized items exceeded $24,000; a $500,000 loan at 4% would only accrue $20,000 of interest).

5. Real Estate Lobby Is Extremely Powerful. This is the biggest factor of all. The real estate lobby (that includes builders) is exceptionally powerful, and most of the lobby is opposed to the above referenced provisions. B/c of this, I am not particularly worried about the provisions at this point.

Jay Voorhees at (925) 855-4491
Real Estate Broker, CA Bureau of Real Estate, BRE# 01524255, NMLS# 335646