My search for a new apartment sucks more because of the mortgage interest deduction
by pdxblake
This post is going to piss off some of the people who own a house, but here goes (leave the hate mail in the comments, please). I am searching for a new apartment and I have noticed that the market has become significantly tighter than it was the last time time before last when I was searching for a place to live, which it so happens was before the financial crisis.
The statement I am going to make that will piss off most home owners is that I feel twice screwed by the mortgage interest deduction. The first is obvious: I don’t own a home so I don’t get the mortgage interest deduction (not to mention the ability to itemize deductions).
The second is a little more complicated, but gives me a chance to run through some economics. The mortgage interest tax deduction is a subsidy for leveraged home ownership (it only applies if you pay interest every year on a mortgage).
This is a simple supply & demand curve. What the mortgage interest deduction does in its most simple effect is increase demand (from the blue to the turquoise line, D’) because if you buy a $200,000 house, and pay $10,000 in interest every year (and you are in the $35% tax bracket), you save $3,500 every year in taxes, every year until you pay it off (30 years from now).
The value of $1 is higher today than getting $1 in 30 years, but it still has value in the future (the calculation for how much less that dollar is worth to you is based on the ‘discount rate’; a 10% discount rate implies that getting $1 in a year will make you just as happy as if you got $0.91 today). So if you add up all those 30 years of savings on your taxes (discounted to the value today, the present value), it works out (with the assumptions above) to about $36,000.
Because you are going to get something (a tax cut) worth about $36,000, you are going to be able to buy more house than if you didn’t get that tax deduction.
Across the entire economy, that will push up demand for single-family homes over apartments (although apartment owners get to deduct interest as well) because more people will buy a house (in part, to get the mortgage interest deduction), and there will be more houses than apartments built in the economy.
Now, take that world, add a bunch of foreclosures and make it really hard for anyone to get a loan to build a new house or buy an existing house. What happens? There are going to be a lot of people who delay buying houses (because credit is tight) and a lot of people who used to own a house who are now back in an apartment (after a foreclosure or short sale), and there is an inadequate supply of apartments for the new demand.
And welcome to my world. I am not going to be too much of a ass about it, but the people who used to own homes and used to get a tax deduction that is not available for renters make up a portion of these people now driving my rents up and making it really hard to find a reasonably priced apartment. Thanks guys, and thank you, mortgage interest tax deduction.
A Flea in the Fur of the Beast 
The mortgage interest tax deduction, like Texas’ homestead property tax exemption, increases the marginal rate of substitution of houses for apartments; repealing it would drive up apartment demand and make the market worse from your perspective.
Aren’t apartments owned by someone? Isn’t that ownership usually through the form of a mortgage? Wouldn’t removing the deduction increase the cost of ownership? Wouldn’t that then increase the cost of renting at all times? Also, in your example the benefits of ownership apply to one mortgage held for thirty years. Each new home purchased requires something like 5% of the value of the house to acquire in fees, so in your example the opposite of a deduction of $10,000. This means it is cheaper to own than rent if you do not move more than once every seven years (not including inflation) (4×10=$40,000 > $36,000) but more expensive to own if you wish to move more often. Without the deduction it would never make sense to own, thus vastly increasing the cost of rent because of demand (at least in the short term) skyrocketing. In this recession rental prices go up because of increased demand. Increased demand happens because renting, even at higher prices, is more attractive than owning. Be thankful you are renting. It’s cheaper for you than owning, has less risk (you can’t lose your life savings), doesn’t require sudden outlays of cash if something breaks, and is far more flexible. Owning a house only makes sense when the appreciation of a house rises more quickly than inflation as a whole (like the stock market) and you plan on staying in that house for years.
You make some good points.
-Yes, the properties are owned by someone, and they get to deduct the interest expense under a different tax deduction (business interest deduction). If you removed that deduction, you would increase the costs of renting to make the property ownership economical for the landlord.
-There are costs for buying and selling homes. If it is included in the mortgage then it generates interest that is deductible against income.
-I don’t think it would not make sense to own a home without the deduction, but it would affect the cost-benefit analysis (but that is not the only reason people buy homes). In the short-run, that would lead to higher demand for rentals, raising their price (the rent). However, it would also make them more economical (particularly if the business interest deduction were left in place) and increase building of apartments that would balance out the market (which is likely to happen now, as well). It would be a longer-term process that would see rents rise first, then fall.
-There are definitely benefits to renting in terms of repair costs, that is most certainly true.
-You can lose your life savings on a house, and that risk increases as the down payment decreases (because you are leveraging the investment, which increases returns and risk). But, because homes are bought with between 3% down (FHA loans) and 20% down, for the most part, and the owner gets the gains with a fixed debt load, the impact of a rise in the price of 1% leads to a benefit to the homeowner of between 5% (with 20% down) and 33% (with 3% down). The bubble in real estate with 0 down loans (crazy) effectively made the return from a 1% rise in prices infinite (can’t divide by 0).
Your points are well put, and I didn’t include enough caveats in the post, mostly because it was a rant, but perhaps should have. Would it be more sensible to phase in an elimination of the deduction over 5 years? Only limit (not eliminate) the deduction to exclude a portion of the deduction pro rata to the amount the house is valued over the median home price in the region? Exclude vacation homes? Cap the amount of the deduction?
In any case the mortgage interest deduction increases the marginal rate of substitution for home ownership over renting, which by definition increases the elasticity of demand for rental units and relieves pressure on their price. While it may be problematic for other reasons (hardliners argue that any government intrusion to increase liquidity in a market drives up asset prices and facilitates bubbles), the mortgage interest deduction favors renters by reducing the number of competing ‘buyers’ (the rental market actually being a market for buying/selling leases).