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FTHB & Millennials
Introduction to iEmergent's First Time Homebuyer / Millennial Model: Part 2 of 2
Just before Christmas, President Donald Trump signed the Republican tax cut bill into law, the most significant revision to U.S. tax law in three decades. The measure cuts tax revenue by a total of $1.5 trillion over the next ten years according to calculations by the Joint Committee on Taxation, a congressional office. This represents a 3.4% cut in expected federal receipts over the time period.
While much has been written about which segments of the American public will benefit most in the new tax regime, this discussion focuses only on the expected impacts to the housing and mortgage markets. Those impacts come in two categories: direct impacts on taxpayers due to the new rules, and then the macroeconomic impacts that will be a consequence of money shifting in the economy.
The new tax reform law directly reduces incentives that support homeownership. The “standard deduction” is doubled to $12,000 for single taxpayers ($24,000 for joint filers)  which significantly reduces the number of taxpayers that benefit from itemizing deductions for mortgage interest expenses and property taxes. Analysts from the National Association of Realtors (NAR) report that only 5-8% of tax filers who itemized in 2017 will continue to benefit from itemizing for these deductions, meaning that for over 90% of those taxpayers, there will be no tax incentive for owning versus renting a home .
Furthermore, mortgage interest deductions are capped to debt up to $750,000 only ($1 million for existing loans); and state and local tax deductions are capped at $10,000. Previously, these deductions had no cap.
These tax features will tangibly reduce home values. Moody’s Analytics, a forecasting firm, estimates the tax law reduces national home values by 3.7%. Since prices have been increasing at about a 6% annual rate, it will slow down average home value appreciation this year (6% - 3.7% = 2.3%). Moreover, in high-home-value, high-property-tax areas (for example, New Jersey, Connecticut, and parts of California), the deduction caps create larger home value declines of 10% or more, so prices in some of these areas could actually fall.
Home equity mortgage interest will no longer be deductible, unless specifically used for home improvement. Recent surveys have shown that up to half of HELOCs and 2nd mortgages have gone to big-ticket financing (like cars, tuition, vacations), debt consolidation, and other non-home-related purposes. Demand for these home equity uses will decline.
Those are the most critical direct impacts of the new law, but there will be macroeconomic consequences to the tax cut that will impact the housing market as well. Some of those impacts will not be immediate but will occur with a lag.
The tax cut will stimulate the economy, at least in the short term. It will mean more money in taxpayers’ pockets to increase consumption, and more money for corporations to invest and/or reward shareholders and employees. Several coompanies have already announced tax cut employee bonuses. The MBA has boosted its real GDP growth forecast by 0.25% for 2018 citing the effect of the new law, and Moody’s Analytics estimates the tax cut will increase 2018 GDP by 0.36%. The employment situation, already the best it has been in a decade, will get even better for workers as the unemployment rate dips below 4% and wage growth accelerates.
Such conditions will raise housing demand. Home sales and mortgage purchase originations in 2018 will be higher than what was expected before the tax bill passed. Home construction, which has lagged household growth for several years, will increase but will take time to ramp up, so already low inventories will cause home prices to accelerate later in 2018 and into 2019.
Meanwhile, the tax cut will increase the budget deficit and raise Treasury borrowing needs, and this will raise bond yields. In the wake of Congressional approval of the bill, bond yields have already risen to their highest levels in more than 3 1/2 years.
For the mortgage market, this means interest rates will be higher than expected, so it will be more expensive to get new mortgages. This will only partially offset purchase demand, but it will reduce refinance originations more than expected. At iEmergent, we believe the positive impact of higher housing demand and the negative impact of higher mortgage costs will net out to a positive 5-7% shift in our 2018 purchase originations forecast, with bigger impacts in the lower cost states and more muted impacts in the higher cost states. On the refinance side, we will lower our 2018 forecast by about 10%.
In the longer term, lagged effects from the tax cut will ripple through the economy. Since this GDP stimulus occurs at a time when the economy is already at full employment, it will increase inflation primarily caused by accelerating wages. By 2020, many economists believe that the increased inflation and interest rates caused by the tax cut will be a net drag on the economy, more than offsetting the continuing stimulus. That doesn’t necessarily mean the current expansion will end. It just means that by then, this tax cut will have a negative effect, not a positive effect, on economic growth.
The bottom line is that the tax cut presents a mixed bag of outcomes for housing and mortgage markets. For lenders, it means higher purchase volumes but lower refi volumes as well as fewer home equity opportunities. For homeowners, it means higher home values, despite the negative hit on tax benefits, the impact of which will be larger in the high cost states. For homebuyers, it means more expensive mortgages and an even tighter housing market, as well as fewer tax benefits to buying. Depending on who and where you are, it will definitely be a game-changer.
 It should be noted that the impact from the doubling of the “standard deduction” will be mitigated and, in many cases, eliminated entirely by the repeal of “personal exemptions” in the new tax law. In 2018, personal exemptions would have been $4,150 for each taxpayer, spouse, and dependent per household.
 NAR’s very good analysis can be found here.
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