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Home Ownership In 1997 Under President Clinton's Second Term
by Stephanie A. Chisholm
Slow but continued economic growth with moderate inflation appears to be the direction for 1997. Lower federal budget deficits combined with a moderately growing economy means continued low inflation levels in the 2.5% to 3.5% range. While significant budget problems lurk just beyond the horizon, problems with social security, Medicare and the interest on the national debt will not manifest themselves until well into the next century.
S low but continued economic growth with moderate inflation appears to be the direction for 1997. Lower federal budget deficits combined with a moderately growing economy means continued low inflation levels in the 2.5% to 3.5% range. While significant budget problems lurk just beyond the horizon, problems with social security, Medicare and the interest on the national debt will not manifest themselves until well into the next century.
The down side to this type of economy is that home owners will not be seeing dramatic home price increases like those seen during the 1980s. On the positive side, the likelihood of a great decrease in home prices similar to that seen in the 1988-1992 years is greatly reduced.
Home Ownership Tax Deductions
The home mortgage interest and property tax deductions for tax payers continue to be sacred cows in Congress. These tax benefits allow consumers to reduce their gross income by the cost of mortgage interest and property taxes paid for a primary residence. For example, a home owner with income of $50,000 in 1996 who paid $10,000 for interest and property taxes would only have to pay taxes on $40,000 ($50,000 - $10,000 = $40,000). On the other hand, a renter with income of $50,000 and $10,000 in rent expense would still have to pay taxes on the full $50,000 of income.
These deductions are worth thousands of dollars per year to home owners. Overall, the tax deductions cost the U.S. Treasury over $60 billion per year. Despite this gigantic subsidy, the popularity of the program and the entrenched interests protecting the deductions virtually assure that they will not be eliminated in the near future. These special interests include The National Association of REALTORS, The National Association of Home Builders and The Mortgage Bankers Association.
While interest and property tax deductions will most likely not be axed, there may be a move to limit them in the future. The mortgage interest deduction is limited to mortgage loans up to $1,000,000 under current law. Needless to say, very few home owners bump up against this ceiling. Moreover, when this limit was put in place in the 1980s, most wealthy borrowers simply reduced their mortgage amounts to below the $1 million mark. As a result, efforts by Congress to collect additional real estate taxes from the wealthy were thwarted.
Nevertheless, there has been talk of reducing the maximum mortgage deduction to $250,000 or $300,000. The justification for this reduction is that the deductions were originally put in place to maximize home ownership in the United States. For most home buyers, $250,000 will buy at least a starter home. Above that amount, it is simply a matter of what type of home and the deduction will not spell the difference between owning and renting.
The Capital Gains Tax
The other major aspect of U.S. tax policy that affects home buyers and sellers is the capital gains tax. Capital gains tax is tax on the profit from buying then selling an asset such as a stock, bond or property. The concept of eliminating the capital gains tax has always been a major Republican initiative, but has traditionally been scoffed at by Democrats as a special deal for the wealthy. At present, the current capital gains tax rate of 28% is slightly below top marginal income tax rates.
The big news for home buyers and sellers in 1997 will be President Clinton's campaign promise to eliminate the capital gains tax on home sales for profits below $250,000. Currently, if a home owner sells a home for a profit, capital gains tax must be paid on the gain. However, Congress made an exception for home owners moving from one home to another. If a tax payer has a gain, he or she may postpone paying tax on it if they use the money to buy a more expensive home within two years before or after the sale. This tax benefit has allowed home owners to move up to ever larger homes while postponing taxes due until well into the future.
When the future does come, there is yet another benefit for home sellers. If a home seller is at least 55 years of age on the day the sale closes, he or she may be able to avoid paying taxes on up to $125,000 of the gain on the sale. Tax payers may take advantage of this exemption, known as the one-time exclusion, if the property has been a principal residence for three of the five years preceding the sale and several other conditions are met.
President Clinton plans to do away with the one-time exclusion along with any capital gains tax on the sale of a principal residence. While capping the profits at $250,000 to $300,000, this proposal would free up home owners to buy and sell homes when it would be best for them. Under the current tax code, most home owners hold off selling until age 55 when they may have a need or desire to sell well before that time. If this policy were enacted, the real estate market would most likely see an explosion as the many home owners waiting for age 55 could sell their homes sooner.
The likelihood of passage for this proposal is probably an even bet at the start of the year. While the program is wildly popular among all home owners and buyers, the popularity of the program and the benefits it brings (such as an increased home ownership rate) must be balanced against the stark realities of the still-looming federal budget deficit.
Federal Government Programs: FHA, VA
A centerpiece of federal housing efforts has been the FHA loan program run by the Department of Housing and Urban Development (HUD). This mortgage program has helped numerous first-time home buyers overcome obstacles that would have been insurmountable under conventional mortgage programs. With lower down payment requirements, lower asset requirements and looser credit standards.
In 1996, President Clinton signed the fiscal 1997 VA/HUD appropriations bill which contained four FHA streamlining amendments. The most important clause for home buyers included a provision to reduce the cost of FHA mortgage insurance from 2.25% to 2.0% of the loan amount for buyers who complete home ownership counseling. The other three amendments streamline processing of the loans, which can now be completed directly by private mortgage lenders offering the FHA program. For Veterans Administra-tion loans, the bill will result in a slight decrease in interest rates on VA loans.
In 1997, it is possible that FHA may consider privatizing the loan program and developing it into a company such as Fannie Mae. Most special interest lobbyists are against this plan, however, fearing that program requirements would be tightened and many first-time home buyers would be unable to obtain financing anywhere. While the FHA program does serve a specific sector of the market, many private lenders have developed their own programs in conjunction with non-profit housing agencies that are often more liberal than the FHA program. As a result, home buyers should still have ample programs available no matter what the future status of the FHA program.
Warning for Real Estate Investors
While most real estate benefits for home buyers and owners appear that they will remain intact, real estate investors serving the low- to moderate-income housing markets may be in for a rude awakening. Many landlords of low-income housing rely on HUD's Section 8 rental subsidy program to be able to offer below-market rents. With many of these programs expiring in the next several years, many Section 8 subsidies to local cities and towns will be reduced or even eliminated. Just as welfare reform is sweeping the nation with respect to cash payments, so will other subsidy programs for housing, food stamps and medical care also come under attack in the next Congress. Landlords are advised to analyze how they would continue with a complete cut in Section 8 funding.
Stephanie A. Chisholm is publisher of the Mortgage Almanac.