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How Will Changes to the Federal Income Tax Impact Borrowers & Lenders?

The Tax Cuts and Jobs Act, considered this country's largest tax overhaul in 30 years, was passed by both the House and Senate on Dec. 20. President Trump signed the final bill into law on Dec. 22, which will have significant implications for American consumers and businesses. Some of the provisions in the law could impact disposable income and have an effect on borrowers and lenders in the coming years.

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What Are Some of the Major Points of the New Tax Bill?

The new tax reform bill is a $1.5 trillion tax act, meaning that the nation's deficit will increase by this amount over the next decade. The corporate tax rate is coming down from 35 percent to 21 percent beginning in 2018, and there is no longer an alternative minimum tax for corporations. The expectation is that corporate earnings will go up, which will spur additional growth that benefits wage earners.

The new bill does lower individual tax rates across the board starting in 2018, although those reductions are not considered permanent. Under the old tax code, our seven individual tax rates are: 10%, 15%, 25%, 28%, 33%, 35%, and 39.6%. There are still seven tax brackets but the new rates are: 10%, 12%, 22%, 24%, 32%, 35%, and 37%.

As of the 2018 tax year, the standard deduction has been increased nearly twofold from $6,350 for a single filer and $12,700 for married couples filing jointly, increasing to $12,000 and $24,000 respectively. The personal exemptions have been entirely eliminated, which equates to $4,050 for each spouse and dependant in 2017. The bill preserves the state and local tax deduction for filers who still want to itemize, but that is now capped at $10,000.

The new bill also doubles the child tax credit to $2,000 and provides a temporary $500 tax credit for the support of non-child dependents, which could be an adult child with a disability or an elderly parent.

How the Tax Changes Will Impact Disposable Income

Changes to our nation's tax laws will likely create a shift in how much families have to spend each month. Yes, the tax brackets for individuals have been lowered so take-home pay will go up in theory. How much or how little the change in the bottom line for a family is will depend on many factors.

Because the personal exemption is now history, that alone could completely negate the gains from the doubled standard deduction. Another important consideration is healthcare. The new tax law eliminates the individual mandate that was part of the Affordable Care Act. Now that all Americans aren't required to purchase health insurance, there's a real possibility that we'll see a reduction in the insured population which is going to cause rates to skyrocket. The Congressional Budget Office estimates a 10 percent increase in premiums due to repealing the individual mandate, but it could be much higher. This, of course, will significantly reduce a household's disposable income.

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We can take the impact on the economy from healthcare changes even a step further. This tax plan as a whole is expected to reduce the government's role in healthcare since there are now talks of future cuts to Medicare and Medicaid. According to the Bureau of Labor Statistics, four million new healthcare jobs were expected to be added to the U.S. economy between 2016 and 2026, which is 35 percent of all job growth. If these program cuts take place, job growth in this sector is likely to stagnate.

In the end, a majority of Americans will likely either see no overall tax cut at all or a tax hike in the long run. Most of the breaks for individuals are set to expire after a few years because of limits on how much Congress is allowed to add to the deficit. However, because of the permanent changes to the corporate tax code, some of the more wealthy Americans will receive longer-term benefits.

The Effect of New Tax Laws on Students and Their Parents

There is good news and bad news for those worried about education-related tax breaks. First, the final bill leaves many of the tax breaks that were once on the chopping block in place. For example, teachers can still deduct $250 annually that they spend on classroom supplies. Other deductions and credits were left untouched such as student loan interest deduction ($2,500 per year), the Lifetime Learning Tax Credit, and the American Opportunity Credit.

One provision of the earlier bill that worried graduate students would have treated waived tuition as taxable income. These waivers are often given to research and teaching assistants, and the benefit will remain in place.

Parents who wish to take advantage of private schools received a win going forward. Up to $10,000 annually from a 529 savings account can now be used to pay for the cost of sending a child to a public, private, or religious elementary or secondary school. Unfortunately, the new tax rules could hurt public schools and taxpayers at every level.

We pointed out earlier that the state and local tax deduction, referred to as "SALT," is now capped at $10,000 annually. The problem is that public schools, including public colleges and universities, rely on state and local tax revenues for their funding. If their attempts to raise funds are unsuccessful, public school quality is going to suffer, and public universities may need to raise tuition to offset shortfalls. Several states also have their own tax credit scholarship programs that favor investment in private schools over public, which also allows the investors to reduce their state tax burden.

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Will Tax Law Changes Make Housing More or Less Affordable?

One of the biggest issues with tax loopholes for homeownership is that it tends to push up home prices to the point that housing becomes unaffordable to all but a select few. Take what happened after the passage of the Taxpayer Relief Act of 1997 and the Community Reinvestment Act as an example. The acts made capital gains exempt up to $500,000 for married couples and required lenders to loan to a subprime market. Between 1996 and 2005, the median home price in the U.S. soared 78 percent from $121,900 to $217,500. It appears that we may face a problem of the opposite nature with the new tax law the attempts to close some of those loopholes.

One of the primary concerns of consumers, businesses, and lenders regarding the U.S. economy and monetary policy is the availability of affordable housing. Even if everyone received more disposable income, it wouldn't go far if home prices skyrocket, interest rates soar, or there is a shortage of available housing units. The new tax legislation keeps the deductions for mortgage intact, with a cap of $500,000 on loans that qualify, a reduction from the $1 million cap in the prior law. Even so, many Americans won't use the deduction because the doubled standard deduction means that more are going to stop itemizing come tax time.

Unfortunately, this new legislation is going to depress housing price growth because many of the incentives for buying a home have simply disappeared. The cap on SALT puts limits on deducting property taxes, and homeowners are also now unable to deduct interest on a home equity loan. Most importantly, the cap on mortgage interest deduction has been lowered from a $1 million loan to a $750,000 loan.

Analysts don't necessarily believe that we're going to see a housing crash or a reduction in housing prices nationwide, but the growth that was anticipated in the housing market will now be much lower because of this bill. According to Moody's Analytics, home prices will be 4 percent lower than anticipated by mid-2019. High-priced areas will see housing price reductions, however, with estimates for the value lost in the New York City/New Jersey market between 9%-10% or higher.

How Changes to the Federal Income Tax Could Impact Lenders

It's difficult to gauge how the federal income tax changes are going to impact lenders over the coming years since the bill contains so many changes to the current plan. In the short-term, there's a chance that families who had planned to purchase a home could hold off out of fear or uncertainty. On the other hand, the promise of additional interest rate hikes this year might be incentive enough to push borrowers into moving forward with their home purchase plans. If disposable income drops for consumers, loan originations could go up as a way to bring more purchasing power to the household.

Lenders holding a loan portfolio with various asset classes may wish to take the opportunity to review those loans as we begin the new year. Considering the tax law changes, some asset classes may now be more profitable than others while some may carry more risk going forward. Fortunately, a partnership with an asset management company can allow a lender to choose between buying loans and selling a loan to minimize risk and maximize profits in the short and long-term.