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Experts Argue Whether FHA Should Insure Zero-Down Loans Staff - Mortgage Lenders Plus.com

President Bush's Advisory Panel on Federal Tax Reform is likely to propose next week a change in the deduction for home-mortgage interest that, if adopted by Congress, would have a drastic impact, especially in regions with high housing prices.

Today, a married couple filing jointly can deduct interest on up to $1 million in mortgage debt.

In a meeting earlier this week, the panel agreed to recommend lowering that limit, perhaps to the maximum mortgage that can be guaranteed by the Federal Housing Administration.

The FHA limit varies by region, but in most of coastal California it is $312,895, the highest FHA limit anywhere in the United States except Hawaii. But it falls far short of the typical mortgage needed to buy a house in that area, where the median price for an existing single-family home was $726,900 in the second quarter, according to the National Association of Realtors.

If, for example, a San Francisco area couple bought a $700,000 home and borrowed 80 percent or $560,000, they could deduct interest on up to $312,895, but not on debt over that amount, under the tax panel's preliminary proposal.

Such a plan is not likely to pass Congress, but it could spark interest in changing the hallowed mortgage-interest deduction.

The nine-member advisory panel, appointed by Bush, has been meeting in public and private since February to discuss ways to reform and simplify the nation's tax laws.

The panel includes two former U.S. senators, a former U.S. representative, four professors (two from California), a former Internal Revenue Service commissioner and the chief investment strategist for Charles Schwab.

Bush asked the panel to recommend ways to simplify federal tax laws, redistribute the "burdens and benefits" of federal tax "in an appropriately progressive manner while recognizing the importance of homeownership and charity in American society."

On Tuesday it will meet one last time and prepare a formal proposal, of which the mortgage-interest deduction is one part.

The panel has not decided whether its new mortgage-interest rule would apply to existing homeowners but is likely to recommend grandfathering them in under the old law, says Jeff Kupfer, the panel's executive director.

"There was a pretty clear consensus, with the state of the market (and housing's growing role in the economy), we would have to be exceedingly careful about how it was implemented," Kupfer says.

Real estate and mortgage experts give the panel's mortgage-interest proposal, as discussed, little chance of passing.

"It's a trial balloon," says Doug Duncan, chief economist of the Mortgage Bankers Association.

"I think it's dead on arrival," says Ken Rosen, professor of real estate and urban economics at UC Berkeley's Haas School of Business. "It's very biased against California and New York and favorable to Texas."

The FHA loan limit throughout Texas is $172,632. That's more than enough to buy a median-priced home in Houston ($142,500) or Dallas ($149,100), according to the Realtors Association.

Linda Goold, tax counsel with the National Association of Realtors, agrees that the panel's proposal has little chance of passing. But, she says, "it has to be taken seriously because of the difficult fiscal situation we're in. Plus, if you are going to repeal the alternative minimum tax in a revenue-neutral manner, the money has to come from somewhere."

The tax-reform panel has proposed abolishing the individual alternative minimum tax, a separate and mind-bending system that raises taxes for a growing number of Americans. Unless Congress intervenes, 30 million Americans will owe AMT in 2010, up from about 2 million in 2002, according to the Congressional Budget Office.

"Repealing the individual AMT will cost $1.2 trillion. Either that has to come from higher taxes or reduced tax expenditures or some combination," says Elizabeth Garrett, a University of Southern California professor who serves on the president's panel.

Garrett admits the panel's plan would be a hard sell.

The mortgage interest deduction is the "third rail" of tax policy, she says. "This may well be a proposal that is not immediately embraced by the Congress. But I do think having this discussion is very important. We put things in the tax code and we don't periodically assess them," Garrett says.

"One thing this panel can do is put ideas on the table that need to be discussed in the public realm."

Garrett says the current mortgage-interest deduction is unfair because it subsidizes very large homes and gives the biggest benefits to those in the highest tax brackets.

A $1,000 deduction saves you $350 if you are in the 35 percent tax bracket but only $150 if you are in the 15 percent tax bracket.

She says a more equitable alternative the panel discussed would be a tax credit based on mortgage interest. A credit reduces your tax bill dollar for dollar, regardless of income.

Garrett also questioned whether the current mortgage interest deduction might encourage homeowners to borrow more than they can afford to repay or take out riskier loans, such as interest-only loans, which maximize one's tax deduction.

Real estate experts predict that if the mortgage-interest deduction were drastically reduced, home prices would fall, especially at the high end. This would be true even if existing homes were exempted and the new rule were phased in a possibility the tax panel discussed.

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(Distributed by Scripps Howard News Service, www.shns.com.)