With the end of 2012 approaching, negotiations regarding the so-called "fiscal cliff" have intensified in Washington. The fiscal cliff represents a series of spending cuts and closed tax loopholes that would save the government a significant amount of money each year, dramatically reducing the deficit over time and promoting a balanced budget for the first time in over a decade. Otherwise known as sequestration, the fiscal cliff is widely considered a worst-case scenario that could have damaging impacts on the wider American economy.
The impacts on real estate are no less scary, though they will be far less dramatic than the ones felt by homeowners a few years ago. The looming fiscal cliff, if not avoided, could cause housing prices to take another dip, disrupting the gradual and ongoing recovery of home values around the country. They could further plunge the U.S. economy into recession, creating even more worries for residential and commercial real estate owners.
The Mortgage Interest Tax Credit is a Potential Victim
One of the central pieces of the sequestration cuts that will take place on January 1, 2013, is the limitation of the current Mortgage Interest Tax Credit. That tax credit is actually a huge financial benefit for almost every homeowner who does not yet own their home outright. Under the plan, that tax credit would be reduced to a mere 28 percent from its current value, and that could seriously harm the financial picture of many homeowners nationwide.
In studies done since the sequestration cuts were developed and passed by Congress, a number of real estate companies and professionals have looked at how the reduction in the tax credit would affect home values. In virtually all studies, the consensus was that homeowners could see a reduction in their home's value from as low as 5 percent to as much as 15 percent. Those in the highest income brackets, with the largest mortgages, could see an even bigger drop as large as 19.6 percent in some cases.
This drop in home prices would lead to the start of a new recession, as American net worth would decline from already low levels and an ongoing recovery in the housing market would be turned back around. For this reason, accommodating the fiscal cliff without major cuts to the Mortgage Interest Tax Credit is of serious concern to real estate professionals nationwide.
Home Sales Likely to Dip Again, As Well
Another effect that will be felt after the Mortgage Interest Tax Deduction has been greatly reduced will be the overall lower levels of home sales. This will affect both the purchase of non-rental second homes, as well as the purchase of first homes by new homebuyers altogether. Home sales have risen in a vast majority of markets nationwide over the course of 2012, and some improvement was even seen in 2011. With less money refunded by the government through tax deductions and reimbursement programs, home sales are likely to decline back to recessionary levels seen in 2008, 2009, and 2010.
That's just not good news for homebuyers, and it isn't good news for homeowners, either. The combination of lower values and fewer sales will make the economy feel very "2008" in nature. Real estate professionals, likewise, should prepare for tough times ahead as sales would get very hard to make in this type of climate.
The Best News: Economic Impacts Would Be Felt Gradually
The fiscal cliff is not as dramatic as it sounds, at least not at first. The cuts that would go into effect would be more slope-like in nature, occurring over time. That would cause the economy to shrink by at least 4 percent, but only gradually. Homeowners might have a brief glimmer of hope that Congress may avert the wider impacts of failed negotiations early next year, sparing them the worst impacts.
Even so, the fiscal cliff represents a real threat to the recovery of the American housing market. That recovery has only recently taken hold, and it's likely that a failed fiscal cliff compromise could seriously impact homeowners with reduced home values, far lesser tax credits, and a home buying market that looks just as bleak as it did when President Obama took office.