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Without subscribing to sensationalism, we examine how proposed changes to the tax code could raise your borrowing costs and affect your property value.

This blog isn’t one for sensational claims, but I won’t be surprised to see similar headlines making the rounds of questionable media outlets before long. We’ll try to cut through the noise and offer a level-headed perspective worth your consideration.

Amid all the noise from Washington, there are two groups making a legitimate attempt to propose meaningful deficit reduction plans. The first is the Deficit Reduction Commission, whose sensible recommendations were highlighted in our January post. The second is a tight lipped “Gang of 6.” This group of six Congressman, equally represented by both sides of the aisle, claim to share a desire to enact significant deficit reform. This evening there is concern that the gang may be reduced to five amidst frustration and a perceived impasse. Even in the event this amounts to a hung jury, it offers another glimpse into the most likely of tax code revisions.

It is this early look that will give some irresponsible journalist the ammunition to proclaim all sorts of radical changes on the horizon. We’ll try to take a far calmer approach. There is one proposal in particular that appears to be recurring: The notion of modifying the mortgage interest deduction (the ability to deduct the interest you pay to the bank from your taxable income via an itemized deduction). Here’s why the proposal has potential to be signed into law:

* First, the proposal will gain traction because it is sly. It can be disguised not as a tax increase, but rather a far more acceptable modification of your itemized deductions. Most will recognize there isn’t a nickel’s worth of difference between the two, but politically you can see how the latter is easier to sell to your constituents.

* Second, it can easily target the so called “rich.” The eventual policy change may only affect borrowers with more than $X00,000 of mortgage debt. Polls suggest the vast majority of Americans are in favor of taxing higher wage earners. This would be an easy way for Congress to take a few more dollars from those often cited as having the ability to pay a larger share of the bill.

* Third, it’s confusing. I know they talk about simplifying the tax code, but I see no evidence of it and these proposals are certainly no exception. There is a relatively easy opportunity for Congress to cap the deduction for mortgage interest at a certain percentage as opposed to the current law whereby all interest is deductible at the taxpayer’s highest tax rate. For example, a borrower whose earnings are currently subject at the 25%-35% tax bracket appreciates the ability to reduce his or her taxable income by taking a deduction for mortgage interest at those rates. An alternative proposal would limit the deduction to 15%. This increases the tax-adjusted borrowing cost rather substantially. A fair number of people won’t even bother to do the math. Politicians like those kind of tax increases — I mean “revisions” to the tax code.

It may be early to make a substantive call on the implications of these proposals, but there are some areas of particular risk already being identified as targets, including the high end housing market and second homes. Conventional thinking would suggest that such legislation would be a negative for all housing markets as borrowers would be reluctant to extend themselves in their purchases, but I’m not convinced that’s the case. The housing market is due for another struggle in the near-term because of the spike in foreclosures being processed on borrowers unable to meet their commitments despite fully tax deductible interest. It is reasonable to suggest that legislation encouraging more responsible borrowing may actually lead to a decrease in foreclosures and help stabilize home prices with time. This remains to be seen.

For the overleveraged, this is another wake-up call as there is some truth in even the most outlandish of headlines. Many will find their borrowing costs will increase rather substantially if a significant portion of first and/or second mortgage interest that was once fully deductible no longer qualifies for such generous tax treatment. That may add pain to an already tight budget.

The prudent investor shouldn’t be particularly alarmed or concerned. He simply takes this opportunity to calmly revisit his plan to eliminate mortgage debt and in doing so sidesteps Washington’s artful attempt for yet another tax increase.