Fiscal Cliff and Tax Changes a Threat to the Housing Market

Everything seems to be hanging on to a solution of the inevitable "fiscal cliff" which is looming over the economy. It seems obvious that if left as it is, there will be a big impact on the overall economy, as well as, the housing market recovery. As the end of year draws closer, the reality of the fiscal cliff and other potential tax changes in the coming year are a real threat to the housing industry, and ultimately the mortgage industry, in several ways.

First, the elimination of the mortgage interest tax deduction would have an impact on the decision of home buyers, as well as, existing homeowners. As it stands, homeowners are permitted to write off mortgage interest from income taxes, also known as the mortgage interest deduction. This is something that is generally important for new homeowners, especially those who take on 30 year mortgages. The amount of interest paid is usually significant enough to be able to take this deduction. Existing homeowners who are refinancing through traditional mortgage refinances may find that they no longer can use this deduction after a few years, especially those who reduce the term of their loan. As less mortgage interest is paid, this deduction becomes less effective unless a homeowner has a large amount of other deductions that need to be itemized. For this year, as a very large number of homeowners used HARP 2.0 and the FHA streamline refinance to lower their mortgage rates, the elimination of the mortgage interest tax deduction would be a financial hit on many homeowners.

Until now, points paid to reduce the mortgage rate can be deducted the year a home is purchased and over the life of the loan for those that obtain a mortgage refinance. This deduction has been an enticement for homeowners to pay to have a lower rate which results in a lower monthly mortgage payment, as well as, build equity at a faster pace. In addition, property taxes are also deductible for those that itemize. These deductions may also become an issue of consideration at the chopping block in the coming year 2013.

Another tax break ending December 31st is the discharge of mortgage indebtedness. Since 2007, any debt forgiven by a lender by way of a short sale, foreclosure or loan modification could be excluded from ordinary income. Since its inception, many consumers have used this tax break, especially in recent years. Beginning in the new year, a consumer will owe taxes on the difference between the short sale amount and the amount that is owed on the loan. At a typical 28% tax bracket, this could add up to a large amount of money and become another financial burden to previous homeowners.

Profits gained from the sale of a home could also be at risk. Right now, up to $250,000 of profit from the sale of an owner occupied home ($500,000 for a married couple) can be excluded. This would most likely hit those in higher cost homes, but could hit those who are older and downsizing. The capital gains tax in general is causing many high end homeowners to sell now, prior to January 1st, in order to avoid paying higher taxes next year. A change in capital gains tax could have an affect on this sector of the real estate market, as well as, the jumbo mortgage market which has seen improvements this past year.

Another less obvious threat will be higher taxes for everyone. If a solution is not found, many consumers who may be saving for a down payment to purchase a home, may find that they will be using their savings to pay income taxes. This is a threat not just to housing, but to the entire economy as consumers will have less available cash to spend which is what creates economic growth.

As of now, everything is hanging on a thread as negotiations for some of these issues have come to a halt while some haven't even started discussion. At this point, homeowners and home buyers have just a few weeks left to make a move to purchase or refinance in 2012. No one can predict what will happen, but whatever it is, everyone will probably be affected in some way down the line.

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