Congress wants to "Put a Cap in Yo Deductions"---Yes, it is as threatening as it sounds.

One such deduction (among several) is the "Mortgage Interest Deduction".  Here is a quick explanation and example.

If I get a loan to buy a house my payment consists of two things: Principal and Interest. 

There are potentially other things included in your payment (i.e. State and Local taxes, mortgage insurance, etc--but we are going to ignore those for now to keep it simple).

The principal is the portion of the loan I actually borrowed and interest is the portion of the loan that compensates the lender for lending me that money. Below is an example of someone taking out a loan for $200,000 at an interest rate of 5% and is going to pay back the loan over a 30 year period.


Source: GMAC

Notice in the "Loan Summary" the "Total of Payments" are $386,513.24. Remember, I borrowed only $200,000 so the difference between these two numbers represents the "Total Interest Paid" on the loan in 30 years--$186,513.24.  ALMOST as much as I borrowed in the first place!!

Over time, in each monthly mortgage payment I make, I pay a portion of the principal and a portion of the interest to the lender.  This is reflected in the data below the Loan Summary.

I listed the first year of payments, 1-12.  Each month the borrower made a monthly payment of $1,073.64.  Each month part of that payment is Principal and part is Interest. You can see that in the early stages of a loan, the interest is MUCH higher than the principal you pay back.  This is called a "front loaded" loan where you pay most of the interest up front and as you make payments the payback for principal increases and interest payback decreases.

In the first year you pay a total of approx $9,930.00 (I rounded) interest alone (Principal was only $2,946.00)

As incentive to buy homes, Congress allows homeowners to deduct the amount of interest from their taxable income.

For this homeowner, if they have enough other deductions to qualify to itemize these deductions (like the charitable deduction or deduction for State and Local Taxes), then they can DEDUCT from their total income the amount of interest paid---$9,930.00.

This effectively reduces the income that will be subject to the Federal Income Tax by $9,930.00, hence their tax bill be less as well.  This is a GOOD thing for the homeowner.  However, it reduces the amount of Federal tax revenue received by the Federal Government.  Consider it a "subsidy" for home ownership.  Renters do not get a similar subsidy. Neither do people who pay cash for their houses.

The larger the home loan, the larger the interest paid, the larger the deduction and the more that homeowner "saves" on taxes. 

The mortgage deduction is a popular "middle class" to upper class tax break. 

There is some talk about limiting this deduction to a smaller amount or getting rid of it altogether.  This will increase taxes on people with home loans, especially those in the early stages of a home purchase with a substantial home loan.

I don't think the total elimination will happen.  Probably a "cap" on TOTAL deductions will be put into place (the home mortgage PLUS charitable, state and local taxes, etc). 

Hope it helps you understand this issue a little better.