Skip to main content

Why Mortgage Subsidies Are Actually Bad for Homeowners

Brendan Brown

From a fundamental economic perspective mortgage subsidies are a bad idea. It is a popular delusion that these subsidies benefit new homeowners. To the contrary, they produce windfall gains for present owners only when first introduced — most of all in areas of the residential real estate market where new land to build homes is scarce.

Expect tax reform to immediately catapult to the top of the policymaking agenda following this November’s presidential election, and in particular, one main hot-button, perennial item: the possible savings from eliminating the tax subsidies in the residential mortgage market. In fact, that subject is broader than merely the tax deductibility of mortgage interest. It stretches to the subsidies stemming from Federal Reserve balance sheet expansion and the virtual government guarantees of debt issued by the government-sponsored enterprises.

Estimates of the total amount of mortgage subsidies in play in the mortgage market vary widely and range as high as $150 billion. Approximately half of that total is from tax deductions, and the other half from Federal guarantees and Fed balance sheet expansion. The capitalized present value over a 30-year period, for instance, could be as high as $3.5 trillion, compared to a total housing stock valued at around $27 trillion — not a trivial sum.

This transfer overwhelmingly benefits the “old wealth” in the housing market, and those who pay for it are today’s new entrants to the homeownership market; present tenants (who in many cases pay higher rents and prices in general than otherwise); the general taxpayer (who could get a tax cut if the mortgage subsidy were scrapped) and, ultimately, a multitude of savers. The extension of government guarantees to the GSEs and the significant expansion of the Fed’s balance sheet raise the likelihood that high inflation will eventually emerge as the chosen tool of national insolvency.

That’s not the intended outcome of any thoughtful public policy.

In most cases, the subsidies prop up inflated prices so that homeowners do not suffer any erosion of the premium they paid at their original entry point resulting from the subsidies in existence then.

Yes, in some cases, these subsidies — and related incentives such as lower initial deposit requirements — may allow households to afford homeownership sooner than if they did not exist.

But a good number of these households might have appreciated the opportunity to take the alternative longer route into a homeownership market where prices would have been lower without the subsidies.

To demonstrate these points, consider two worlds.

The first is the one we know, which features the triple subsidy of tax deductions for interest paid, the mortgage debt virtually federal government-guaranteed, and long-term spread suppression (between yields on mortgage paper and U.S. Treasury bonds) which was a result of the Federal Reserve’s vast balance sheet expansion in over the past eight years.

The other world has no subsidy. Home prices would surely be lower than in the first scenario. The only exception: those areas of the real estate market where supply conditions were so favorable that any increase in demand for housing due to the subsidies could be met at the same long-term price. There, rents would have fallen as some tenants switched to homeownership and total dwelling space would increase, resulting from new construction.

The annual servicing cost for leveraged homeownership in these areas would be lower in the second world than in the first.

By contrast, where supply conditions were unfavorable (perhaps due to strict zoning regulations) the price of homeownership would be higher in the second world than the first. Perhaps highly- leveraged borrowers, even at the higher price, could see some net tax decrease in their annualized dwelling cost.

Everyone else, most of all the nonleveraged homeowners, would experience an increase. And even the highly leveraged buyers could not claim to be better off. The subsidies would have incentivized them to take on excessive debt, exposing them to an elevated level of risk. The price of an individual home is subject to an array of risk factors which get diversified away in a large portfolio. But these benefits of diversification cannot be achieved by most homeowners for whom their home is probably their main asset.

If policymakers were to start over, they would not introduce mortgage subsidies unless it was as a part of a dirty tricks campaign aimed at persuading gullible voters desperately seeking the benefits of homeownership, or as part of a campaign to increase the supply of homes in areas where supply is flexible. But in that latter case surely a more effective means of subsidy would be increasing the tax deductions possible for investment in new buildings rather than artificially stimulating leverage.

Related Articles

Home Sales Set Records for Minorities Across America

John C. Weicher

In the midst of the volatile economy riven with uncertainty because of the coronavirus, there is some welcome news from the housing market. Home sales...

Continue Reading

Hudson Announces Launch of New Podcast and Media Fellows

Hudson Institute

Hudson Institute announced today the launch of a new podcast, The Realignment, hosted by Media Fellows Saagar Enjeti and Marshall Kosloff....

Continue Reading

The Long-Term Dynamics of Affordable Rental Housing

John C. Weicher et al.

This project investigates the affordable rental housing market over the three decades from 1985 to 2013....

View PDF