Mortgage Tax Deduction May Be at Risk, Quietly Wounding Mortgage Payers

President Obama's recent budget proposal may wipe out your mortgage deduction. Is this the right time to cut incentives to homeownership? The housing industry, at record lows and bulging with home inventory, is loudly protesting.

Currently, households taxed at the 33 and 35 percent rate can claim mortgage deductions. However, under the newly proposed Obama Federal budget the deduction would be eliminated for anyone over the 28 percent tax bracket. In the 2009 tax year that would mean those households making more than $208,850 in taxable earnings will not be eligible to claim a mortgage deduction.

The elimination of the mortgage deduction for this income tax bracket seems to tie to the president's campaign promis to increase taxes on households earning over $250,000.

In a statement from the Mortgage Bankers Association, CEO David Kittle says the timing couldn't be worse. "This proposal could have an adverse effect on a market that is already in trouble, and this is not the time to reduce incentives for buying or refinancing a home."

Advocates of eliminating the tax deduction argue that first-time home buyers are rarely at the high-point of their earning potential. Therefore, it will have little impact on the recovery of the housing market.

However, consulting IRS data shows the disincentive may be larger than expected. Lower-income households rarely itemize deductions, so the incentive only applies to the upper two-thirds of income levels. And according to the most recent IRS study, conducted in 2003, 36 percent of those claiming a mortgage deduction had adjusted gross incomes exceeding $100,000.

The National Association of Realtors (NAR) battled a similar Bush proposal in 2005 that would have eliminated the deduction in exchange for a 15 percent tax credit. NAR argued that removing the deduction would directly decrease the value of homes, especially in high-cost areas like California. Some econometric studies demonstrate that the tax beliefs of homeownership add 5 to 7 percent to the value of a home.

Taking away key incentives for those that can afford to own homes seems counterproductive. Meanwhile, the government is considering incentives for lower-income home buying--bringing back seller down payment assistance. A program that is documented by FHA to directly correlate to increased mortgage defaults.

It seems that where the government is placing the incentives on mortgages and housing may make the housing crisis worse.

The Obama administration appears to be agressively battling the mortgage crisis with foreclosure prevention aid packages, while quietly wounding folks that continue to pay their mortgages--the only strength in the mortgage market.