Mortgage Down Payment & Tax Subsidies Promoting home ownership Economic Implications (& Benefits) of Home Ownership Homes are crucial to low-income families for financial asset building. Over 66 percent of the total net worth of low-income homeowners is stored as home equity. Homeowners are less likely to move, staying in a community up to four times longer than renters, allowing them to get to know one another better and establish social networks. Businesses benefit, as employees with owneroccupied housing are more likely to form a stable workforce. Economic Implications cont Homeowners are more willing to contribute to political campaigns and to lobby public officials than renters. Homeowners are also 16 percent more likely to belong to parent-teacher organizations, block clubs and other community organizations. Children of homeowners are 116 percent more likely to go to college than the children of similar renter families, even after controlling for age, income and length of stay in the community and 59 percent more likely to become homeowners themselves. Economic Implications Cont The construction of 1,000 single-family homes supports nearly 2,500 full-time jobs in construction and construction-related industries, $80 million in wages, and $43 million in combined federal, state and local revenues and fees. Homeownership also provides individuals an investment in real estate while benefiting from having a place to live. Homeownership Barriers and Policy Responses Lack of income to afford the monthly payment of principal, interest, taxes and insurance Lack of net savings to put into a down payment and closing costs and/or high debt Poor credit history, which results in an increased interest rate, exacerbating income constraints Lack of information on how to shop for a home and apply for a loan Lack of quality affordable units in a desirable location Barriers to Homeownership Lack of Income Lack of Wealth and/or High Debt Poor Credit History Lack of Information Lack up Housing Supply Federal Policy Response Mortgage Revenue Bonds, Mortgage Credit Certificates Government Sponsored Enterprises, Deductibility of Mortgage Interest, Section 8 Homeownership Option FHA/VA/RHS Mortgage Insurance, HOME, CDBG, CDFI Down payment Grants and Loans FHA/VA/RHS Mortgage Insurance, Mortgage Revenue-backed Loans Truth in Lending Act and Real Estate Settlement Procedures Act Disclosures, HUD Section 108 Counseling Grants National Manufactured Home Construction and Safety Standards, HOME, CDBG, CDFI Grants and Loans 1
U.S. Homeownership Rate: 1996--2005 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 US 65.4% 65.7% 66.3% 66.8% 67.4% 67.8% 67.9% 68.3% 69% 69.1% Whites 71.7 72 72.6 73.2 73.8 74.3 74.7 75.4 76 75.3 Blacks 44.1 44.8 45.6 46.3 47.2 47.7 47.4 48.1 49.1 48.1 Latino 42.8 43.3 44.7 45.5 46.3 47.3 47 46.7 48.1 49.1 Asian/others 50.8 52.8 52.6 53.1 52.8 53.9 54.6 56.3 59.8 59.9 Source: http://www.freddiemac.com/news/factbook/pdf/reporter-factbook-p6.pdf Tax Subsidies and Homeownership Past researches found tax subsidies have increased the homeownership rate. These tax subsidies lowered the relative prices of owning to renting. For example: Rosen and Rosen (1980) found if all personal income tax subsidies for homeownership were eliminated, the homeownership rate would decrease by 4 percentage points. There four types of tax subsidy to homeowners in the U.S: Mortgage interest Tax Deduction Real Estate Tax Deduction Capital gains exclusion Exclusion of net imputed rental income on owneroccupied homes History of Mortgage Interest and Property Tax Deduction The deduction of interest expenses was not limited to home mortgage interest, and the deduction of local and states taxes was not limited to property tax in the earliest versions of the income tax the Revenue Acts of 1864 and 1865 and the Tariff Act of 1913. The 1986 Tax Reform eliminated the deductibility of nonmortgage consumer interest and various state and local taxes, but not the mortgage interest and real estate tax deductions. Although the these two deductions were preserved in the 1986 Tax Reform, their value was substantially reduced by the reduction in marginal tax rates, which meant that each dollar in deductions represented smaller tax savings. How they work? Under current tax law, Interest on mortgage loans on the first or second home is fully deductible, subject to the following limitations: home acquisition loans up to $1 million, and home equity loans up to $100,000. (If you are married but file separately, the limits are split in half.) Acquisition loan: A mortgage you took out to buy, build, or substantially improve your main home or second home. Home equity loan: A mortgage you took out other than to buy, build or substantially improve your main home or send home. Example of home equity loan: you took out a $20,000 loan, secured by your home, to pay for your daughter s college tuition and your father s medical bills. This loan is home equity loan. How they work? (continued) Each year, lenders will send you a IRS 1099 Interest form in January in accordance with the federal tax laws. The IRS 1099 will show the total mortgage interest that you have paid for the past year. This figure is put on the IRS 1040 Schedule A under the mortgage interest line. The real estates taxes, both state and local, can be deducted. The real estate tax will be reported to you by the tax agency in your states. This figures is put on the IRS 1040 Schedule A (line 6). How they work? (continued) Example: if you made $40,000 and paid $ 5,000 in mortgage interest and $ 3,000 in real estate taxes, the $8,000 in mortgage interest can be deducted from your income, leaving a tax basis of $32,000. To deduct mortgage interest and property tax expenses, you must file Form 1040 and itemize your deductions on Schedule A (Form 1040). If you itemize, you cannot take the standard deduction. Many lower and moderate income families don t itemize their deductions and may have little or no tax liability, thus can t take advantage of these two tax breaks. 2
Capital Gains Exclusion Beginning in 1951, homeowners were permitted to roll over the gain from the sale of one home if they bought another home of equal or greater value. The 1964 Revenue Act introduced a once-in-a-lifetime exclusion of all or part of the gain on sale for owners ages 55 and over who trade down or become renters. Under 1997 Taxpayer Relief Act, you can keep, tax free, capital gains of up to $500,000 if you are married filing jointly or $250,000 for single taxpayers, or married taxpayers who file separately. To qualify this exclusion, the home must have been your primary residence of record for at least two of the prior five years. So long as you meet the primary-residence-of-record, two-out-of-five-years requirements you can take the exclusion as often as you meet the qualifications -- for life. Exclusion of Net Imputed Rental Income on Owner-occupied homes Homeowners are their own landlords and they should be taxed on the rent that they implicitly receiving from themselves. Obviously, they are not taxed on this. The Cost of Tax Subsidies to Federal Government( in billion dollars) Deductibility of mortgage interest Capital Gains exclusion Exclusion of net imputed rental income Deductibility of state and local property tax Total 1996 $55.87 23.08 22.91 18.69 123.61 2000 66.57 20.48 27.29 24.45 138.79 2005 68.87 32.84 28.60 16.59 146.9 2010 92.79 64.98 40.44 11.56 209.77 Source: Carasso, Adam, C. Eugene Steuerle, and Elizabeth Bell. 2005. Making Tax Incentives for Homeownership More Equitable and Efficient. Tax Policy Center Discussion Paper No. 21. Washington, D.C.: The Urban Institute. What is Wrong with Current Tax Subsidies? Researches found federal housing benefits are not distributed very rationally, efficiently, or equitably. Most benefits goes to high income people. Reschovsky and Green(1998) estimated that replacing the current tax deduction on mortgage and property tax with refundable tax credit will increase the homeownership rate. In addition, tax credit will produce a more equal distribution of tax benefits across income levels. Green and Vandell (1999) found replacing the current structures of deductions with a revenue-neutral level tax credit to all homeowners, homeownership would increase 3 to 5 percent in the aggregate and up to 8 percent for the lowest-income households. Using the Urban Institute-Brookings Institution Tax Policy Microsimulation Model, Carosso etc. estimated how the current combined distribution of the mortgage interest and property tax deductions by quintiles of cash income. (see table 1). Option 1: Fixed Percentage Interest Credit Repeals the mortgage interest deduction and replaces it with a fully refundable tax credit equal to 16.7 percent of mortgage interest paid. (see table 2) 3
Option 2 Flat Mortgage Interest Credit Repeals the mortgage interest deduction and replaces it with a fully refundable tax credit equal to 1.03 percent of home value up to $ 100,000 (maximum of $ 1,030) (see table 3) Option 3 Flat Real Estate Tax Credit Repeals the real estate tax deduction and replaces it with a fully refundable tax credit equal to the lesser of $ 280 or 50 percent of real estate taxes on the primary residence. (see table 4) Option 4 Flat Tax Credit in Lieu of Mortgage Interest and Real Estate Tax Deductions Repeals the mortgage interest and real estate tax deductions and replaces them with a single, fully refundable tax credit equal to the lesser of $ 1400 or 100 percent of the real estate tax on the primary residence. (see table 5) 4
Tax Reform Proposed by Presidential Tax Advisory Panel in November 2005 The biggest change the panel called for was replacing the deduction for mortgage interest with a tax credit. This credit would be equal to 15 percent of the mortgage interest paid by a taxpayer on a loan that was secured by the taxpayer's principal residence, and used to acquire, construct, or substantially improve that residence (home acquisition loan). The President's Advisory Panel on Federal Tax Reform also recommended the elimination of the deduction for mortgage interest on second homes and on home-equity loans. The proposed new cap on mortgages for which interest can be deducted -- ranging from $227,147 to $411,704 depending on a region's housing prices. Source: http://www.washingtonpost.com/wpdyn/content/article/2006/01/06/ar2006010600724.html?nav=rss_realestate History of FHA & VA Mortgages Until 1930 s homeowners who financed their home typically made a downpayment of at least 40 percent, paying only interest for three to five years, until a final balloon payment of principle was due During the Depression many people defaulted on their loan because they couldn t make the final balloon payment The National Housing Act of 1934 created the FHA insurance program to protect lenders from the risk of default After World War II, Veterans Affairs began to guarantee low-downpayment mortgages made to veterans In 1968, the Housing and Urban Development Act established Ginnie Mae as part of HUD to guarantee FHA & VA loans sold by private lenders What are FHA & VA Mortgages? The Federal Housing Administration, generally known as "FHA", provides mortgage insurance on loans made by FHA-approved lenders throughout the United States and its territories. FHA insures mortgages on single family and multifamily homes including manufactured homes and hospitals. It is the largest insurer of mortgages in the world, insuring nearly 33 million properties since its inception in 1934. (contituned) VA guaranteed loans are made by private lenders, such as banks, savings & loans, or mortgage companies to eligible veterans for the purchase of a home which must be for their own personal occupancy. The guaranty means the lender is protected against loss if you or a later owner fail to repay the loan. The guaranty replaces the protection the lender normally receives by requiring a down payment allowing you to obtain favorable financing terms How FHA/VA Achieves it s Purpose: More consumers qualify, because the government is willing to take part of the default risk through mortgage insurance -Lenders are more willing to lend -Borrowers are more capable of borrowing *Since the government is taking some of the risk away, consumers have more choice in the area they live in *Down payment requirements can be low *Borrowers can finance up to 97% of their home *Closing costs may be able to be financed with the mortgage *FHA regulates the fees that lenders can charge borrowers 5
Downfalls and Side Effects Consumers may take on more debt than they can afford due to poor education, overestimating financial resources, poor planning, pressure from lenders to purchase a home Consumer Education & Counseling In an effort to decrease the number of foreclosures on homes it has been suggested to increase consumer education and counseling, and perhaps make it mandatory. This would be done through Nonprofit organizations Local governments Ousing agencies Lenders Mortgage insurers Real estate agents Public schools Faith-based organizations Public awareness campaigns Results Research done by Freddie Mac demonstrated that pre-purchase homebuyer counseling and education has a measurable, positive impact on loan performance Face-to-face counseling, as opposed to that provided by a workbook or telephone, reduces defaults by up to 34 percent But Many buyers do not want to take time to sit in classes or prepare workbooks before looking for a home and mortgage. Taking part in education and counseling can slow down the buying process, potentially jeopardizing a purchase offer. Provision of homebuyer education and counseling is expensive, $100 to $300 depending on the length, intensity and content, which many first-time borrowers lack resources to pay for. Finding a qualified provider of homebuyer education and counseling can be difficult. 6