Hopefully you’ve been following the recent deficit reduction proposals by the commission in charge of finding ways to reduce the deficit.  No doubt, this is a difficult task for all involved which will invariably result in everyone tightening their belts in the unified attempt at “shared sacrifice”.

However, what sort of sacrifices are on the horizon?  For the purposes of this article, we’ll discuss the home loan interest tax deduction as there are many other tax cuts on the chopping block.

What?  Don’t You Touch My Mortgage Interest!

Yes, it’s true!  This treasured tax deduction enjoyed by homeowners for decades is on the chopping block.  CBS MoneyWatch reports:

One of the three tax plans offered up by the co-chairs of President Obama’s fiscal deficit commission would end the mortgage interest deduction on primary-home mortgages above $500,000, down from the current limit of $1 million. The deficit-cutting duo also proposed to completely eliminate the deductibility on second homes and home equity loans and lines; currently up to $100,000 of interest on such loans and lines qualify for the tax break.

While nothing is finalized, I’m sure this has both homeowners and Realtors foaming at the mouth ready to pounce on the likelihood that whoever votes for this measure will not see another term in office.

So what are the potential ramifications of this change?

I am on the fence about whether or not it will tank the housing market as many seem to think.  Still, we have some information from the slump post $8,000 home buyer tax credit earlier this summer, more on that later.  Similar proposals like the Ronald ReaganTax Reform Act of 1986 phased out the ability to deduct the personal interest from your credit card purchases didn’t tank the industries it targeted.  Since 1986, I don’t think the credit card industry has been hurt one bit.  Reports of billions in profit since that time I assure you.

What’s the likelihood that this will actually go through?

If there seems to be a shared sentiment that everyone needs to tighten their belts and share in the pain to cut the deficit then it might become a reality.  Long gone are the days of double digit appreciation within the same year as we saw during the boom.  So I do think now is the time to institute something like this to help reduce the deficit while forcing more people to live within their means.

Will this lead to a double dip recession for the housing market?

Let’s look at housing numbers shortly after the $8,000 home buyer tax credit expired.

Realtor.org reported:

Following a surge driven by the home buyer tax credit, pending home sales fell with the expiration of the deadline for qualified buyers to sign a purchase contract, according to a report released Thursday, July 1, 2010 by the National Association of Realtors (NAR).

The Pending Home Sales Index, a forward-looking indicator, dropped 30.0 percent to 77.6 based on contracts signed in May from a reading of 110.9 in April, and is 15.9 percent below May 2009 when it was 92.3. The falloff comes on the heels of three strong monthly gains as home buyers rushed to take advantage of the tax credit, which expired April 30.

Existing-home sales that close in June will remain elevated, but we’ll then see a notable decline for July and August.”

This information tells us that potential home buyers in this recession are more likely to be inclined to lock themselves into a long term financial arrangement with a bank when the government gives them incentive to do so.  I am of the opinion that if this tax deduction is removed/adjusted as proposed, we may see an even deeper decline in the housing market.  This may result in a much needed correction (tethered to the adjustment of the deduction)in line with the limitation of said deduction to homes no more than $500k.

But wait, you coasters are itching to tell me that finding a home below $500k is darn near impossible.  Living in the DC Metro area, I can see how that would be true for some, but not all and certainly not impossible.  We live in troubling times and if finding a decent home below $500k is a problem, then it is a relatively good problem to have.  My advice?  If you can’t find a home you want to buy for under $500k then rent one until you can afford to buy one regardless of the tax credit.  Or, rent one.  One of the enduring lessons of any recession is forcing people to live within their means.  Even if it means finding a home for less than $500k.

Your thoughts?  What do you think are the possible implications with eliminating the mortgage interest tax deduction?  Are you likely to purchase a home of the tax deduction of mortgage interest is adjusted to a limit of $500k?