The report takes an in-depth look at the impact proposed changes to the tax code could have on the housing and mortgage markets—reporting that the tax reform, in its currently written state, could worsen the tight housing inventory, while increasing housing expenses for buyers.
The House tax reform plan proposes doubling the standard deduction while capping the mortgage interest deduction (MID) to the first $500,000 of mortgage debt, while the Senate version also doubles the standard deduction, but leaves the MID cap at $1 million.
Black Knight’s analysis notes that doubling the standard deduction would provide greater benefit to renters than homeowners—while reducing the tax incentive to purchase a home by making the MID less valuable to borrowers.
“We’ve observed in the past that positive tax incentives can certainly impact home buying decisions – the Black Knight Home Price Index (HPI) showed clear evidence of this as a result of 2008’s first-time homebuyer tax credit,” said Black Knight Data & Analytics EVP Ben Graboske. “However, limited data is available to examine the effects of removing an existing tax incentive on borrowers’ purchase behavior.”
Graboske continued, “One thing that seems clear is that a reduction of the MID could further constrain available housing inventory, which itself has helped to push home prices even higher in many places.”
There are currently 2.9 million active first-lien mortgages—current mortgage holders, which have original balances exceeding $500,000, or the cap proposed in the House version of the tax bill.
Existing mortgage holders would be exempt from this new cap, as they can still deduct interest up to $1 million. Therefore, if one of those homeowners sells and buys a same priced or more expensive home, the MID on subsequent loan would be capped at $500,000.
“The question now becomes whether the proposed tax reform adds another layer of ‘tax deduction lock’ on the market,” added Graboske. “Do these homeowners now also have a disincentive to sell their home in order to keep their current interest rate deduction of up to $1 million? If so, this would potentially add new supply constraints.”
While lower-priced markets may not experience a great impact from these changes, the most recent HPI reported 22 markets nationwide where the median home price is over $500,000. The report notes that “Mortgage originations at or above that point have increased by 350 percent since the bottom of the housing market.”
In this current state, the market could experience an estimated 480,000 purchase originations in 2018 with original balances over $500,000, with an estimated 2.9 million over the first five years of the tax plan.
“Even if interest rates stayed steady around 4 percent, a $500,000 MID cap could cost the average homeowner with a larger mortgage an additional $2,600 – $4,200 per year depending on their tax bracket, representing a 6 to 10 percent increase in housing-related expenses as compared to the average annual principal and interest payment today,” Graboske explained.
Additionally, Black Knight’s data found that the national delinquency rate experienced its second consecutive annual rise—currently at 4.44 percent—driven in large part by the impact of the recent hurricanes’ continued impact on the mortgage market.
Meanwhile, foreclosure starts are up by 11 percent month-over-month. Despite the increase, October’s 50,200 foreclosure starts marked the second lowest number of monthly starts since 2004.
In addition, prepayment activity rebounded from September’s 15 percent drop, increasing 17 percent month-over-month in October.