The Real Impact of Tax Reform on Home Buying
The dire “Chicken Little” warnings from economists, real estate and mortgage industry leaders that the new federal income tax rules will lead to falling home prices and fewer home buyers are, from where I sit at the front lines of real estate and mortgage lending, simply out of touch with reality. Here’s why:
The vast majority of Americans have no idea how much income tax they pay or how that number is calculated. Go ahead and ask the next 10 people you meet or 10 people you know this simple question: “How much did you pay in income tax in 2016?” I’m betting zero people will come within $2,000 of their actual amount paid. At best, the person will know how much money they had to send in on April 15 or how much they got in a refund. But that’s not the actual amount they owed for the full year – it’s just the accounting mop up number.
To get the answer, take a look at Line 63 on Page 2 of your 1040 federal income tax return or Line 39 on Page 2 of your Form 1040A if you did not itemize deductions. There it is. The real number you had to pay Uncle Sam, which by the way does not include the amount you paid into Social Security, Medicaid and Medicare (unless you’re self employed). The reason extremely few normal Americans know how much they pay in federal and state income taxes is because the government devised the most ingenious system ever for lulling us to sleep on the subject. Our employers dutifully “remove the taxes due” from our paychecks and send it to the IRS. Invisible to the common man!
Now add the fact that accountants and registered tax preparer are probably the only humans who understand the difference between a tax credit, a tax deduction and an exemption, and it’s no wonder the eyes of the average Joe (or Joanne) glaze over within 10 seconds of an attempted explanation.
Real people buy and sell real estate for real-life reasons (not tax or financial reasons). In 2017, Accunet closed a little more 1,500 loans. I know of exactly one in-depth conversation that occurred on the topic on the tax deductibility of mortgage interest, and it had zero impact on the first-time buyer’s decision to buy or how much home to buy. The discussion only informed the type of mortgage he ultimately selected.
Real home shoppers do not ask, “What’s the after-tax cost of my mortgage going to be?” Real home shoppers ask these three questions:
- How much house can I afford?
- How much money do I need for a down payment?
- What will my monthly payment be?
The reasons real people buy and sell homes has to do with real-life events and feelings such as:
- I’m tired of paying rent
- I want a place to call my own
- Getting married or forming a household
- Having a child or more children
- Children getting to school age and wanting better schools
- A new job in a different part of town or a different state
- Kids leaving the household and downsizing
Demographics + supply and demand drive home prices, not tax law. The largest generation in America’s history, millennials, is awakening and buying homes (for the usual real-life reasons stated above). In the markets Accunet serves (Wisconsin, Illinois, Florida and Minnesota), there are a lot more eager buyers than homes available for sale. Of course, that still varies according to price range, with the top end of the market softer than the middle and lower ends. But overall, housing inventory is as tight as the lid on a pickle jar with no let up in sight.
The Nobel winning behavioral economist Daniel Kahneman talks about the imaginary “econs” which regular economists imagine will behave in a perfectly rational, financially motivated and disciplined manner according to their Excel spreadsheet models. “Surely if the after-tax cost of owning a home increases, there will be fewer buyers and prices will fall.” Baloney I say! I’m with Kahneman. Real people do not behave rationally when it comes to most economic decisions, including real estate.
The greatest threat to home buying demand is not the tax law but more likely rising mortgage rates, increasing home prices and a lack of increasing wages. When the home buyer asks, “How much home can I afford” and the answer becomes, “Not nearly as much as you’d like” – that’s when we’ll start to have a real problem with demand and when home prices could fall.
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