Mortgage Interest Deductibility for Canadians

Introduced in 1913 into the U.S. code and little used until the 1950’s, mortgage interest deductibility (MID) is considered a sacred cow. Efforts to reduce it, replace it or change it have been met with vigourous opposition.  It is considered part of the American way. It is as American as apple pie. No political party dares to touch it. It has been called an “electric apple pie.”

U.S. MORTGAGE DEDUCTIBILITY

• Homeowners in the U.S. are allowed to deduct not only interest up to $1,000,000 on the mortgages of their primary residences, but also the mortgage interest on a second (vacation) home as well as their property taxes and home equity loans (up to $100,000 home equity debt).
• American taxpayers claim approximately US$337-billion to $434-billion in deductions under this provision. The deduction costs the U.S. approximately between $57 and $63-billion per year. Other economists peg the revenue loss at between $20 and $52-billion¹. These lower estimates stem from the fact (as it occurs in Canada) that households would use some of their assets to pay off their mortgage should they no longer be allowed to deduct their mortgage interest. Since the government would lose the taxes collected on those assets (see example of investments used to pay off mortgage in Canada by higher-income families), these offset the cost of the deduction as it stands now.
• More than 60% of the families who claimed the deduction had family incomes between $60,000 and $200,000.
• Home ownership rates in the U.S. are among the highest in the world, close to 69%.
• While the home-mortgage deduction was introduced to the U.S. tax code in 1913, it wasn’t widely used until the 1950’s. The cost of the deduction has climbed from about $20 billion in 1981 to nearly $70 billion in 2003 (according to estimates from the Joint Committee on Taxation).
• It is estimated that 152,000 households (0.4%) that utilize the deduction show an adjusted gross income of less than $5,000
• Attempts to eliminate the deduction would endanger the strength of the housing market, which many analysts believe helped to bolster the U.S. economy during recessions in 2002 and 2003.
• The home-ownership rate is only 4% higher in an economy with the deductibility than in one without.  Example: Home ownership rate in Canada is around 66%. (8.13 million homes); in the U.S. it is 69%. (Translating to roughly 78.07 million homes).
• The cost to revenue in the U.S. per house ranges from $256 (using the low $20-billion revenue cost) to $807 (using the higher $63-billion revenue cost).

 PROPOSED MORTGAGE INTEREST DEDUCTIBILITY IN CANADA

Parameters:

• Mortgage interest is deductible in Canada with a family income less than $200,000 per year.
• There is a cap on the mortgage interest that an earner can deduct: the interest on the first $100,000 of a mortgage  (In U.S.: mortgage interest is capped at $1-million)
• Only one residential property can be deducted (in the U.S., a second residence is deductible).
• If a two wage-earner couple, the deduction is taken by the earner with the smaller income, thus reducing the deduction expense.
• In a single wage-earner family, the single tax-payer takes the deduction.
• There would be no home equity interest deduction (in U.S.: $100,000 max)
• There would be no property tax deduction (in U.S., the property tax deduction increases the deduction by 20 to 40%)

The Reality:

Wealthy Canadians have been deducting the interest on their mortgage for years. They are able to liquidate their non-registered investments, pay off all or part of their mortgages, take out investment loans and deduct the interest of the investment loans. The cost of this high-end maneuver to Revenue Canada is unknown. Low and mid-income families are either loathe to borrow funds for investment purposes or unable to.

"As Leader of the Reform Party and a founder of the Canadian Alliance, one of my greatest concerns has been the excessively high taxes paid by Canadians. While tax relief through tax reform is urgently needed and will eventually come, the strategy proposed by Fraser Smith offers every Canadian who has a mortgage the possibility of significant tax relief right now. I would encourage you to read Fraser's book and discuss his strategy with your banker or financial planner as soon as possible."

Preston Manning
Former Leader of the Official Opposition

Background

In a paper by Martin Gervais (University of Western Ontario) comparing mortgage interest deductibility in the U.S. and (the lack of it) in Canada, the economists found that in the U.S., 75% of homeowners with incomes between US$100,000 and $200,000 still held mortgages, and 75% of American homeowners with incomes above $200,000 had mortgages. In Canada, roughly 53% of homeowners in that income bracket held mortgages, and 39% of Canadian homeowners with incomes above $200,000 have mortgages on their residences.  Gervais concludes that it remains advantageous in the U.S. to maintain mortgages, as there is deductibility of the interest, along with home equity loans (which many Americans use to finance their children’s university education) and property tax deductions. He concludes that without MID, the Americans would simply re-allocate their assets and pay off their mortgages sooner, like the Canadians. Therefore, the cost for MID for revenue is greatly overstated. However one can draw another conclusion from the higher-income Canadian mortgage percentage:  that more wealthy Canadians are using the investment loan deduction in lieu of mortgages on their homes. The cost of a proposed MID in Canada has been greatly overstated:

1). there is a loss of revenue for CRA already at the higher income, homeowner level because of this loophole;                                                                                                                                                           

2)  there would be no home equity loan interest deduction;                                                                                   

3) there would be no property tax deduction;                                                                                                        

4)  there would be a threshold above which there would be no MID and                                                                          

5) there would be a cap on the amount of mortgage interest deductible.

CANADIAN TAXPAYERS

Jane and Joe Canada:  Tale of Two Wage Earners:

Jane and Joe Canada area married suburban couple with a combined income of $95,150

Jane makes $60,000 per year as a bookkeeper plus $100 interest per year.

Joe makes $35,004 per year as a carpenter in the housing industry plus $50 interest.

Five years ago they took a $100,000 mortgage out with a 5% rate, amortized over 25 years. Over the lifetime of the mortgage, if calculated at 5%, they will pay a total of $74,483 in interest. They pay $582 per month in mortgage payments; their property taxes of $3,500 are paid separately. Last year, the 5^th year of their mortgage, they paid a total of $4,331 in interest.

They have no extraordinary sources of income nor do they have extraordinary expenses: their mortgage payments are their largest expense.

Jane’s federal tax owing:                    $          9,040.00

Joe’s federal tax owing                       $          3,632.00

Total family federal tax owing             $        12,672.00

The government decided to allow the couple to deduct the interest off their mortgage that they paid in 2005, by the lower-income earner (Joe). It was a straight deduction off his taxable income (T-1 Form, Line 256). 

Joe had his federal taxes reduced to $ 2,983.

Jane’s federal tax owing:                    $         9,040.00

Joe’s federal tax owing                       $         2,983.00

Total family federal tax owing              $       12,023.00

         2007 Reduction by MID:                    $ 649.00

And since Joe worked in the construction industry, due to the stimulation that the new deduction afforded the trades, he expected his income to increase next year to $ 39,996.  Then his federal tax payment of $4,625 (with the mortgage interest deduction now reduced to $ 4,197) would be decreased to $ 3,672, (savings of $953) but increased over last year’s federal tax by $689.  Jane’s income did not change, so she still pays $9,040. Their combined federal tax without deduction: $13,665. Their combined federal tax with deduction: $12,976.  2008 savings: $953.

Upper Middle Class: Couple with Two Wage Earners and $100,000 mortgage

Joe139 makes $139,500 a year and his wife Jane60 makes $60,000 a year. They have a $100,000 mortgage and pay $4331 a year in interest. Joe139 is the higher earner and does not take the mortgage interest deduction. His federal taxes are $29,953. Without the interest deduction, Jane60 would pay $9,132 federally. Their combined federal tax is $39,085.  If Jane60 is allowed to take the interest deduction, she will pay $8,179. Their combined federal taxes are now $38,132, a reduction of $953.

JoeRich: Upper Middle Class Couple with One Wage Earner and $100,000 mortgage

Joe Rich makes 198,000 a year. His wife Jane Rich does not work. He has $1000.00 in investment income. They have a $100,000 mortgage (year five) at 5% and they pay $4, 331 a year in interest. Without deductions, Joe pays $46,107 a year in federal taxes. If Joe were able to deduct his mortgage interest, He would pay $44,851 in federal tax, a savings of $1,256.

JoeTaxInvestments: Couple with One Wage Earner, $100,000 Mortgage, $100,000 in Liquid Assets

JoeTaxInvestments makes $199,000 and wanted to find a way to deduct his mortgage interest. On the

advice of his financial planner, he liquidated $100,000 of his non-registered investments, and paid off

his $100,000 mortgage. He then took out a $100,000 investment loan, interest-only payable at prime-plus

0.5% (at this writing 6%).  At 6.5% a year, the investment costs him $6,500.  Joe is able to deduct the $6,500 from his total income. His federal tax is reduced from $46,107 to $44,222, a savings of $1885.

Therefore it is important to note that, for high-income Canadians with investments, a mortgage and the leverage/ability to borrow funds, access to better credit terms, access to paid financial advice, working the Canadian tax rules to essentially deduct their mortgage interest costs more to Revenue Canada (in this case, $44,851 - $44,222 = $629) on a $100,000 mortgage than if they had deducted it directly. 

SingleMother with Two Grown Children (both employed) at Home

SingleMother works as a secretary, is recently separated and makes $30,000 a year.  Her two grown daughters live with her and one of them co-signed her mortgage, so that she was able to afford a $100,000 mortgage on her first home. She pays $4,331 a year in interest. She has no savings, no RRSP. Her federal taxes are $2,918.00.  If she were allowed to deduct her interest on her mortgage, her federal taxes would be $2,269, a savings of $649.  Her monthly mortgage payment is $582.  This savings essentially gave her one month free in her home.  As the Conservative’s New Budget overlooked people in her financial situation (low middle class, grown children, no RRSP, no savings, no deductions) she was actually motivated to vote Liberal in the Federal Election.

COST COMPARISONS

YORK-SIMCOE  OWNERSHIP RATE: 85%, 54.94% owned homes mortgaged  

EXAMPLE GIVEN FOR MORTGAGE $100,000 AT 5% (5^TH YEAR)

(Average for 2 wage-earners based on 70% of homeowners with 2 incomes)

REFERENCES

1. Gervais, M. and Pandey, M. Who Cares About Mortgage Deductibility?

Univ. Western Ontario and Univ. Winnipeg (2006)

2. Statistics Canada 2001 – 2006.
3. Canada Census 2001, York-Simcoe Electoral District
4. Data processed using Microsoft Office Excel and QuickTax 2005