HOW WOULD THE REMOVAL OF THE TAX DEDUCTION ON MORTGAGE INTEREST AFFECT THE HOUSING MARKET?
In a rapidly growing economy, asset prices, such as the value of a home, increase. This makes the expected return from owning a home higher than if the economy is not growing as we've seen in recent years where housing prices have decreased dramatically. The tax deduction on home mortgage interest makes the cost of owning a home lower. The removal of the tax deduction on mortgage interest would affect the housing market by causing the demand for homes to decrease and therefore housing prices to fall even more.
For example, most people base the decision to buy a house primarily on the monthly cost of owning versus renting. You calculate the rental equivalence that combines after-tax mortgage payments, property taxes, insurance, maintenance, and the cost of your down payment. Ginnie M' offers a Buying vs. Renting Calculator just for this purpose. For a given mortgage interest rate, removal of the tax deduction on mortgage interest increases the after-tax cost, leading to a higher monthly payment and, therefore, a decline in demand for owner-occupied housing. This reduction in demand ultimately reduces housing prices, but it is interesting to note that in countries that don't offer a mortgage interest deduction, like England for example, home ownership is about the same as in the U.S. Housing prices, however, are much lower.
Many economists argue that economies are better off when people are making financial decisions based on strong economic principals rather than tax considerations. In fact, some claim that the current housing crisis is due, in part, to increased borrower debt magnifying risk. An interesting question to consider is whether or not borrowers would have bought homes during the recent housing bubble if there had been no home mortgage interest deduction.
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