Tax-Free Accounts for Homes

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Tax-free savings accounts help Americans stow away money for health care and college tuition. Why not a tax-exempt account for yet another major expense: the down payment on a mortgage?

A coalition that includes real estate developers and investors has been floating the idea as part of a package of reforms intended to overhaul federally funded real estate programs. Home loan programs, direct grants and tax credits add up to some $450 billion a year in federal spending that the group says mostly benefits a small proportion of households.

“These programs have an enormous impact across the country,” said Ilana Preuss, the vice president and chief of staff for Smart Growth America of Washington, the group leading the coalition. “Communities have long benefited from these programs, but they could be doing a lot more.”

In addition to proposals to halve the $1 million cap on the mortgage interest tax deduction and beef up support for affordable rental housing, the group suggests that Congress authorize individual mortgage savings accounts to make it easier for would-be buyers to save for a down payment. The program would be limited to first-time buyers who could make pretax contributions to such an account for up to 10 years. Funds put toward the purchase of a home would not be taxed.

“It would encourage individuals to start saving earlier for down payment and closing costs,” Ms. Preuss said, “and it would really make their dollar go further.”

The idea is modeled on a home-buyer savings-account program that has been in place in Montana since 1998. Open to any first-time buyer, regardless of income, the program allows people to deduct deposits of up to $3,000 a year from their state taxable income (not their federal income); married couples may deduct up to $6,000 a year. Interest earnings are not taxed.

At least in Montana, however, the incentive has not done much to step up the savings rate. According to the state’s revenue department, no more than 225 people, and as few as 125, have participated annually since the program’s inception. Their annual deposits have averaged around $400,000.

In 2011, the program cost the state just $24,000 in lost revenue.

“What you’ve got to understand is, this is people trying to get into their first home,” said Edmund Caplis, the department’s director of tax policy and research. “For most working families, trying to pull together an extra buck is a stretch.”

Other factors limiting participation of late have been low interest rates on savings accounts and a lack of publicity about the program, said Maureen Rude, the statewide director of operations for NeighborWorks Montana, a nonprofit housing organization.

What tends to resonate more with first-time buyers trying to scrape together a down payment are programs that offer matching funds for dollars saved, Ms. Rude said. Still, she added, “the more tools that are out there to help people save money, the better, in my opinion.”

The Federal Home Loan Bank of New York operates its own variation on a mortgage savings account program for New York and New Jersey residents. Restricted to first-time buyers earning no more than 80 percent of area median income, the so-called First Home Club provides $4 in matching funds for every $1 saved, up to a maximum grant of $7,500.

In order to qualify for a match, participants must make deposits for at least 10 months and attend financial counseling.

Established in 1995, the First Home Club is administered by more than 70 area lenders, and is regularly fully subscribed, according to Eric Amig, a spokesman for the Federal Home Loan. So far, it has assisted more than 6,800 households.