Neuswanger: New tax rules could change the process of getting a mortgage loan (column)
December 8, 2017
The mortgage industry is watching closely as the tax reform drama (or debacle) unfolds in Washington. It's always been taken for granted that homeowners could deduct their mortgage interest on the first $1 million dollars of mortgage debt and that property taxes would be deductible, as well.
Over the decades of studying actuarial data on the on-time payment performance of millions of loans, in the background was the factor of the homeowners' ability to repay being enhanced by having a lower tax bill at the end of the year. This led to a set of standards that, for the most part, worked well.
In addition, a set of industry standards evolved for the self-employed and small-business owners that evaluated their taxable income based upon the current tax system governing deductions and write-off.
Turbulent Times Ahead
Both of these benchmarks may change radically, and as with all radical changes (particularly ones that are poorly thought out and done in haste), there will be turbulent times ahead.
One change will be the reported plan to limit interest deductions on home mortgages to the first $500,000 in principal and limit property tax deductions to, say, $10,000.
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While we enjoy low property taxes in Colorado, in some areas of the United States, the property taxes are often more than the mortgage payment. And in Eagle County, many middle-class families have more than $500,000 in mortgage debt. Losing or limiting these deductions could have a dramatic impact on an individual's cash flow if he or she pays thousands more in income taxes. This could result in a higher default rate than normal on mortgage loans.
The second, and far more daunting, impact is evaluating the self-employed and small-business owners' ability to qualify for a mortgage.
It appears the Senate version of the bill would replace most itemized deductions, such as mileage, supplies, utilities and travel, with a flat exclusion that might end up in the mid-$20,000 range. There then would be no way for a mortgage lender to determine if the borrower actually had $3,000 in those expenses or $100,000 in those expenses, at least on the basis of tax returns.
Changing the tax brackets may offset the differences for very small businesses and have an enormous impact on more medium-sized businesses.
While no doubt the industry will formulate some way to measure actual net cash flow and impacts, for the first several years, it's going to be confusing for all and, to a great extent, "hit and miss" until actuarial data can be established.
My guess is small-businesses owners will have to have to spend money on audited financial statements, which can cost thousands of dollars a year. No doubt accounting standards will have to be re-evaluated, as now most deductions are considered that if they are spelled out by the tax code.
Until things sort themselves out, which could take many years, this has the potential for making investors skittish of investing in mortgage-backed securities, and that means interest rates will go up to cover any perceived risk.
Chris Neuswanger is a mortgage loan originator with Macro Financial Group in Avon and may be reached at 970-748-0342. He welcomes mortgage-related questions from readers. His website and blog can be found at http://www.mtnmortgageguy.com.