Why Does the Government Allow a Mortgage Interest Deduction?

The mortgage interest deduction allows homeowners to lower their taxable income by subtracting the interest paid on their home loan, which reduces the cost of owning a home. The reasons for this deduction stem from a combination of historical tax policy, social objectives, and economic influences. Understanding why the government permits this deduction requires looking at how tax law has evolved and the goals it is intended to serve.

Historical Origins of Interest Deductibility

The ability to deduct mortgage interest is viewed as a policy to promote homeownership, but its origins are broader. The federal income tax was established with the Revenue Act of 1913. This initial tax code allowed for the deduction of all interest paid on any type of debt, not just mortgages, because the lines between personal and business finances were often blurred and interest was seen as a cost of acquiring assets.

For decades, this all-encompassing interest deduction remained in place. After World War II, homeownership changed with the rise of federally insured, 30-year mortgages making home buying more accessible. As more people bought homes, the deduction for mortgage interest became more significant for a larger portion of the population.

A change occurred with the Tax Reform Act of 1986, which aimed to simplify the tax code. Congress eliminated the deductibility of interest on most personal debt, such as credit card balances and car loans. However, an exception was made for “qualified residence interest,” preserving the deduction for mortgage debt. This act transformed the deduction from a general rule into a specific subsidy for homeowners.

The Stated Policy Goal of Promoting Homeownership

The primary justification for the mortgage interest deduction is making homeownership more affordable. By allowing taxpayers to deduct interest payments, the government lowers the after-tax cost of a mortgage loan. This reduction in borrowing costs is intended to enable more households to move from renting to owning, based on the principle that it will increase the rate of homeownership.

Policymakers also associate homeownership with social benefits. Homeowners are perceived as more invested in their communities, leading to greater neighborhood stability. Because they are less likely to move than renters, homeowners may be more inclined to participate in local civic activities, support local schools, and maintain their properties.

Homeownership is also viewed as a tool for wealth creation for American families. For many, a home is the largest asset they will own, and the equity built over time represents a form of savings. This equity can be borrowed against for major expenses like education or medical bills and serves as a financial cushion for retirement, supporting middle-class economic security.

Supporting Key Economic Sectors

The mortgage interest deduction is influenced by its benefit to several sectors of the U.S. economy. The policy functions as a subsidy for the real estate industry, where agents and brokers benefit from higher transaction volumes and home prices. The National Association of Realtors has historically been an effective lobbying group advocating for the protection of this tax provision.

The home construction industry is another beneficiary. By making home purchasing more financially attractive, the deduction helps stimulate demand for new housing. This supports home builders, construction workers, and manufacturers of building materials, which can foster growth and employment in related fields.

The financial services sector, particularly banks and mortgage lenders, has an interest in the deduction’s preservation. The policy encourages Americans to take out larger mortgages, increasing the volume of loans and interest income for lenders. The collective influence of the real estate, construction, and banking industries has defended the deduction against calls for reform.

The Modern Framework and Its Implications

The Tax Cuts and Jobs Act of 2017 (TCJA) introduced temporary modifications to the mortgage interest deduction that are scheduled to expire at the end of 2025. The law reduced the limit on mortgage debt for which interest is deductible from $1 million to $750,000 for new loans. This change curtailed the maximum benefit available, particularly for homeowners in high-cost housing markets.

More impactful than the debt limit reduction was the TCJA’s near-doubling of the standard deduction. For the mortgage interest deduction to provide tax savings, a taxpayer’s total itemized deductions must exceed their standard deduction. Because the higher standard deduction is greater than the total itemized deductions for many households, fewer taxpayers now find it advantageous to itemize.

The effect of these provisions is that the deduction’s benefit is now concentrated among taxpayers with higher incomes and larger mortgages. Unless Congress acts, these rules will revert in 2026. The mortgage debt limit would return to $1 million, and the lower standard deduction would again make itemizing worthwhile for more homeowners.