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How Do Tax Changes Affect Existing Borrowers?

A significant new tax bill was recently signed into law. The changes are broad, and are likely to have long-term effects. This post provides an overview of how the new tax changes will affect existing borrowers.

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Mortgage Holders

The new tax bill changes both the deductions for mortgage interest and property taxes.

After some debate in both the House and Senate versions of the bill, the new tax changes will retain deductions on mortgage interest up to a mortgage amount of $750,000, a decrease from prior $1 million limit.

While this provision is unlikely to have any impact on mortgage holders whose mortgage amounts are $750,000 or under, it may have an impact on mortgage holders whose mortgages are above that amount. They will no longer be able to deduct the interest above this amount.

This may make their properties less affordable and ultimately, less desirable. As a result, it may lead to some sales of these properties and may make them move slower on the open market.

It remains to be seen how widespread the ultimate effect would be, however, since buyers of these properties are likely high net worth individuals with access to other forms of sheltering income from taxation.

The deduction for property taxes has been reduced significantly for many people. Before the new tax law, homeowners were able to deduct all property taxes, state and local. Under the new tax law, however, property tax deductions will be limited to $10,000. More than 4 million Americans pay over this amount of property taxes annually.

In the short term, the change in the amount of property tax homeowners are able to deduct caused many homeowners to prepay their 2018 property tax in the last days of 2017, before the new tax law took effect

In the long term, this change too may make holding properties with more than $10,000 in property tax less desirable, as homeowners will effectively be paying more to own their homes.

It remains to be seen if homeowners whose property taxes exceed $10,000 will move to homes whose property taxes fall under this amount, but it certainly could be one of the long-term effects. If it does happen, it could make homes with less property desirable, or homes in comparatively lower property tax states more desirable, or both.

It could also affect the real estate market in high property tax states like New York, New Jersey, and California. Currently, real estate prices are high in many areas of these states, and have been rising for some years. But an end to tax deductions for property taxes above $10,000 may make the markets less desirable.

If it does, existing homeowners may see the market prices for their homes drop, especially those on the higher end, who are also hit with a drop in mortgage interest deductions.

Home prices may also be pressured long term by the new tax bill’s change in the standard deduction.

The new tax bill increases the standard deduction by 100%. A homeowner has to itemize to deduct mortgage interest. Some observers have hypothesized that people will be less inclined to itemize and thus less likely to want a mortgage deduction under the new tax bill. If mortgage holding becomes less desirable and renting more desirable, existing real estate may be harder to sell and markets may soften. This affects existing mortgage holders long term, as the return on their investment is affected.

While opinions differ, some argue that legislation serving to make home ownership less attractive over the long term, especially in the high property tax states, may lead to a drop in housing prices overall.

Other observers blame mortgage and property tax deductions designed to foster home ownership for driving up housing prices, making home ownership unaffordable for some.

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Student Loan Holders

While early plans for the tax bill threatened to eliminate tax deductions for student loan interest, the new plan allows holders of student loans to deduct as much as $2,500.

This is good news for student loan holders whose loan amounts don’t exceed the $2,500 interest cap but it is not good news for the increasing number of student loan borrowers whose interest amounts are more than that amount. They will be paying more in taxes under the new plan.

Existing student loan borrowers who are thinking of taking out more student loan debt may look long and hard at those plans now, as the tax-advantaged status of student loan debt has been curtailed.

Conclusions

For existing mortgage holders whose mortgages are under $750,000 and whose property taxes are under $10,000, the new tax plan means no changes in their tax deductions.

Mortgage holders whose mortgages are above $750,000 will be paying more taxes, as will those whose property taxes are above $10,000. Long term, that may make properties in both those categories less desirable, and soften market demand for them.

Existing student loan borrowers can still deduct interest up to $2,500. For current student loan holders who may be tempted to take on more student loan debt, the new cap on deductible interest may make further student loan debt less desirable.

Optimizing Loan Portfolios

Existing loans depend on multiple factors and a host of consumer decisions. No matter any change, lenders should ensure prudent planning to facilitate the continuing strength of their loan portfolios.

Prudent lenders will join with experienced partners to decide on loan sales and acquisitions that will maintain strong results across all portfolios.