By now, the average U.S. homeowner has probably heard numerous news reports about the looming “fiscal cliff.” Many potential borrowers who plan on a mortgage refinance or to buy a home may be unclear about what the fiscal cliff means and how it affects their personal circumstances.
Fiscal cliff refers to financial repercussions of actions the federal government will be forced into taking--in the form of tax increases and budget cuts—if Congress fails to resolve certain budgetary issues as outlined in the Budget Control Act of 2011. The law goes into effect at midnight on December 31, 2012.
Budget Control Act of 2011
The new regulation takes away the temporary payroll tax passed in 2010. As a result, employees will face a 2% increase in payroll taxes beginning with the first paycheck in January 2013. In addition, businesses will take a hit to their bottom line with the following changes:
- Elimination of some tax breaks
- Changes in the alternative minimum tax
- Elimination of tax cuts implemented from 2001-2003
- New taxes related to President Obama’s health care law
According to the financial publication Barron, more than 1,000 government programs, including Medicare, Medicaid, and defense, will suffer funding cuts. Total tax increases and spending cuts will exceed $607 billion dollars. The average household will realize a tax increase of $2,000-$3,000, said Forbes.
The combination of reduced household income, higher consumer cost for health care and other necessities, and lower business investment will likely push the economy back into another recession.
Impact on Housing Market
If the government does nothing, and the tax increases and spending cuts take effect, the changes will reduce the federal debt by $7.1 trillion over ten years, but the recovery of the housing market and the general economy will be in jeopardy. Some economists believe that if Congress takes a moderate approach to solving the fiscal crisis, such as extending existing tax cuts and keeping the mortgage interest deduction for homeowners, it will have a positive influence on the economy.
Jeb Kolko, the chief economist at real estate website Trulia, states that the “best-case scenario is a deal that avoids sharp tax increases and spending cuts next year.” Kolko thinks this approach does not hinder or quash improvements in the economy and will simultaneously help the federal government to put policies in place, which will help to balance the budget and reduce the $16 trillion national debt.
Mortgage Interest Deduction
A solution being bantered about in the halls of Congress, which should concern people who plan to refinance their mortgages or purchase a home, involves the nearly sacred mortgage interest deduction.
This tax breaks increases the household income of millions of homeowners. It also has a positive effect on the overall housing industry—which has a relationship with 122 other sectors of the economy.
Some politicians are discussing limiting the deduction to $500,000 of home value. The current rules allow for a $1 million cap. There is also talk underway that could limit the mortgage interest deduction to homeowners who earn less than $250,000 a year.
The mortgage interest deduction applies to about 35% of the taxpayers who itemize their taxes. Eliminating this item would bring about $100 billion in additional income into the federal government’s coffers, said Stan Humphries the chief economist for the real estate data website Zillow.
The housing industry has been able to survive a market collapse due to exaggerated home values and some financial issues. However, the housing industry is "not completely immune to political and economic shocks either," Humphries said.
Housing Industry Lobbying
As expected, the National Association of Realtors and other real estate organizations have mounted a vigorous lobbying effort to maintain the “hand-off” policy regarding the mortgage interest deduction and other housing enticements. Humphries warns that modifying the deduction, such as capping eligible home value at $500,000, would send home prices plummeting further.
The National Association of Home Builders ' chief economist David Crowe echoes the consensus sentiment expressed by the housing industry as a whole—undertake reforms “ in a measured, careful way," which avoids spending cuts to balance the balance budget usurping the housing industry and economic recovery. Crowe would like housing sector incentives to remain in place—especially the mortgage interest deduction and housing tax credits.
Consumers who plan on a completing a mortgage refinance now or in the future and potential homebuyers should contact their Congressional representatives and make known to the their desire to keep these housing incentives and their incomes intact.