Additional Considerations of A/LM Implications of Recent Tax Reform
May 3, 2018
In early February, the blog post, The A/LM Implications of Tax Reform, addressed some of the potential A/LM considerations of the recent Tax Cuts and Jobs Act. The focus at that time was on the potential challenges and opportunities stemming from:
- Lower corporate tax rate
- Reduction in the mortgage interest cap
- Changes to individual tax rates
We mentioned there would be more to discuss from the relatively new Tax Cuts and Jobs Act. The focus of this follow-up blog is on helping credit unions consider strategic questions and potential impacts from changes to home equity tax code and property taxes.
Home Equity Loans
In our discussions with credit union executives, one concern that rises to the top is the potential for a reduction in demand for home equity loans as a result of changes in what is allowable as a deductible. Changes under the tax reform act now require the home equity loan to be used to buy, build, or substantially improve the taxpayer’s home.
Consider that many home equity loans are used for vacations, debt consolidation or even to purchase a car. In fact, studies show that roughly 50% of home equity loans are used for reasons other than home purchase/improvement.
Uncertainty surrounding home equity loans leads to several strategic questions for credit unions to consider:
- Could demand for home equity loans decrease if interest isn’t entirely deductible?
- How could our interest rate risk profile change if variable rate home equity loans become a smaller part of our structure?
- Could recent tax reform push more members towards our unsecured or signature loan products?
- How can we best communicate with members so that they continue to value our home equity loans?
In the spirit of reducing the risk of losing readers to stimulating tax code details, we can summarize the impact of changes to property taxes by saying there is now a cap on property tax deductions and therefore potentially less benefit of home ownership than in the past.
In many areas, property taxes are on the rise due to recent increases in home values. The S&P/Case-Shiller National Home Price Index graph below shows that nationally, prices have surpassed the previous peak from 2006.
S&P/Case-Shiller U.S. National Home Price Index
The potential decrease in tax benefits from large property tax bills also comes at a time when the cap on mortgage interest deduction is being lowered. The combination of these factors leads to several strategic questions for credit unions to consider:
- Will tax reform make home ownership less attractive and cause real estate lending to slow? If yes, how can that impact our earnings stream?
- Will tax reform cause home prices to decline, potentially leading to increased loan losses?
- What other loan and investment products should be tested in our A/LM model to help replace a potential reduction in mortgage revenue?
At this point, it is impossible to predict the real impact of recent tax changes. However, proactive A/LM discussions combined with testing of potential short- and long-term balance sheet outcomes will help inform strategic implications, if any.