Like a lot of people, I have a mortgage. Unlike a lot of people, I am in a big hurry to pay it off. Most people want to pay interest to the bank, which they can then deduct from their income for tax purposes. I have never understood why you would want to pay money to someone so you can get some of it back.
In effect, mortgage interest is subsidized, meaning you end up paying a lower effective interest rate. A 3.75 percent mortgage becomes approximately a 2.8 percent mortgage, and there are a lot more houses you can afford with a 2.8 percent mortgage. That’s the point. The tax code is designed to incentivize people to buy houses. Not just any houses, but bigger, more extravagant houses — built by homebuilders. We have unintentionally designed a tax code whose intent is to drive people into debt to buy houses, making the economy more fragile. We should instead think about ways to make it more anti-fragile.
The housing lobby yapped about the benefits of homeownership as the House Republican tax plan was being put together, but those arguments sound a little stale after the global financial crisis. Before then, we took the homeownership rate from 63 percent to 70 percent by increasing the availability of credit. We soon found out that those 7 percent of people at the margin had no business owning a house. Let’s face it, the ideal homeownership rate is not 100 percent. Owning a house is a lot of responsibility, for responsible people. For everyone else, there is rent.
Lawmakers and the housing lobbyists seem to think there is some kind of stigma associated with renting. They talk about societal benefits to homeownership, not the least of which is building equity in an asset. So, since we’re talking about assets, let’s compare residential real estate with other assets, such as stocks and bonds.
Homes are not liquid. In the best of times (like now) you can sell them in a few weeks, and the closing process will take another 45 days or so, but you’re looking at a couple of months at least for you to get your money. You can sell a mutual fund and have the proceeds transferred right into your checking account. It may seem a bit paranoid to be worrying about housing market liquidity in 2017, but people have short memories. Lots of folks (myself included) listed their homes for sale in 2010 and were stuck. It wasn’t a question of what the homes were worth, but rather the idea that you couldn’t extract your equity no matter the price. Whenever you invest in something, liquidity should be the first consideration, not the last.
Furthermore, homes have carrying costs that can be quite large. Maintenance needs to be done. Roofs need to be patched. Hot water heaters need to be replaced. In a bad year, this could amount to several hundred basis points as a percentage of the price of the house. Furthermore, the house depreciates. Not as quickly as a car, but without care, the house will lose value over time. And then there are the unknown unknowns, such as the insurance you buy may not cover every natural disaster, as homeowners in Houston recently learned.
Recent history seems to demonstrate that housing prices tend to go up, but that’s dependent on lots of factors such as geography, the local economy, demographics and monetary policy. Even then, you can’t expect homes to appreciate much more than economic growth, and certainly not after taking into account wear and tear.
So, sure, it’s nice that homeownership forces people to build equity in an asset, even if it is a profoundly crappy asset, because left to their own devices, they probably wouldn’t save anything at all. But, ideally, wouldn’t we want people diversified across a range of assets, instead of having all their eggs in one basket?
I hope that one day we will get the real estate lobby out of the tax code. We have a deduction for mortgage interest, which, thankfully, is being partially eliminated under the House tax plan. We have deductions for property taxes, which, thankfully, might also be reduced. And we have an exemption for capital gains up to an absurdly high level. It is the capital gains exemption that I take particular exception to: If you want to encourage speculation on a thing, eliminate capital gains taxes on that thing and keep them on everything else. I was actually a bit shocked at how little the tax code was discussed in the wake of the housing crash in 2008.
This all may be sort of a larger, philosophical issue, but the tax code should not encourage debt and consumption — it should encourage savings and investment. A mortgage is a reasonably complex financial instrument, and I would guess that less than 1 percent of borrowers are capable of building an amortization table for a fixed-rate mortgage in a spreadsheet. And even then, a 30-year mortgage is increasingly unsuitable for a population that is exceedingly unlikely to stay in the same job for 30 years. As we learned a decade ago, all it takes is a small bump in the economy to cause millions of people to start missing payments.
There is no rational reason why residential real estate should be a tax-advantaged investment — even the primary residence. It causes huge distortions, a lesson we failed to learn in 2008, oddly enough. Treat residential real estate like any other financial asset. Eliminate the deductibility of mortgage interest and property taxes. Apply capital gains taxes, just like stocks and bonds. Excessive speculation happens often enough on its own. You don’t need to encourage it with the tax code.
Jared Dillian is the editor and publisher of The Daily Dirtnap, investment strategist at Mauldin Economics and the author of “Street Freak” and “All the Evil of This World.”