How the mortgage interest deduction might be changed

Hundred dollar bill folded in shape of a house

Your mortgage interest deduction is safe for now, but Washington is in a cutting mood.

So there's no telling what might happen as the Joint Select Committee on Deficit Reduction -- Congress' so-called super committee -- nears its Thanksgiving deadline for coming up with a plan to cut government spending over the next decade.

This political football has become a popular target among some lawmakers despite strong lobbying efforts from the real estate and construction industries, in part because of efforts to contest its effectiveness in promoting home ownership.

Those seeking to shore up federal finances are eager to tap into the $470 billion shielded from tax annually because of the deduction.

Assuming there are any changes to the current benefit, the deduction perk could be modified in several ways:

The deduction could become a credit. President Obama’s fiscal commission suggested the home mortgage interest deduction be changed to a tax credit equivalent to a percentage of interest paid. Instead of deducting the amount of interest paid from taxable income, a credit would be a direct, dollar-for-dollar reduction of tax.

Deduction limits could be reduced. One proposal calls for the elimination or reduction of the mortgage interest deduction for mortgages greater than $500,000.

Deductions could be limited to primary residences. This would eliminate the deduction for mortgages taken out on second homes or vacation homes. This proposal would also eliminate the deduction for interest on home equity loans not used to purchase or improve a residence.

Deductions for the wealthy could be eliminated. A 2008 proposal from the Congressional Budget Office would phase out the deduction for those earning above $250,000 per year.

As it stands, you must meet three major criteria when determining whether you can deduct mortgage interest:

The debt must be directly related to a qualified residence. You can own two qualified residences at a time. One must be the place you live; the other can be any other residence you own, like a vacation home.

The debt must be secured by the home. This is usually the case when the you sign a mortgage or trust deed at the real estate closing. Basically, to be qualified residence interest, the debt must give the lender the right to foreclose if you fail to pay the mortgage.

The debt must be as a result of the purchase or a home equity loan. The total of all home acquisition loan debt must be $1 million or less. The total of all home equity loan debt must be $100,000 or less.

Home acquisition debt includes debt incurred to buy, build or improve a home or vacation home. On the other hand, debt will qualify as a home equity loan no matter the purpose, as long as the total amount of debt stays below $100,000.

This allows taxpayers to deduct interest for home equity loans taken out to pay college tuition or medical bills.

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