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Candice Choi

Homeowners have reasons to be concerned as the debt ceiling debate drags on

By Candice Choi
Associated Press / July 30, 2011

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NEW YORK - Homeowners have a lot at stake in the political showdown over the country’s debt ceiling.

One of the major concerns for many is the fate of a valued tax break. The benefit, which allows taxpayers to deduct their mortgage interest payments, is used by 35 million households.

Now lawmakers have proposed limiting the deduction as part of an agreement to raise the government’s borrowing limit to avoid a default after the Aug. 2 deadline. But that isn’t the only concern for homeowners and prospective buyers as the negotiations heat up in Washington.

Even if lawmakers strike a deal by next week’s deadline, there’s still a chance the government’s credit rating could be downgraded. That raises the prospect of higher mortgage rates, meaning those who’ve been holding tight for home prices to fall further may feel that time is running out to take advantage of low rates.

Here’s what you should know:

What will happen to mortgage terms if the government defaults on its debt?

Some borrowers could find it more difficult to get approved for a mortgage. This might happen if banks become more cautious and slow their lending to each other, as they did during the height of the economic collapse in 2008, notes Greg McBride, a senior analyst with Bankrate.com.

The government’s cost of borrowing would also rise if there was an unprecedented downgrade of the country’s credit rating.

Those costs would be felt by all, because the interest rates on consumer loans, such as mortgages, are tied to government bonds.

“Any increase on Uncle Sam’s borrowing would translate to higher costs for consumers,’’ McBride said.

If a default is avoided is there any reason mortgage rates would still rise?

Yes. Depending on the details of an agreement, ratings agencies could still decide to downgrade the government’s debt.

Standard & Poor’s president Deven Sharma this week refused to provide specifics on how much the government would need to cut spending to maintain its top-notch credit rating. But Sharma said some of the plans being floated by Congress could be enough to avoid a downgrade.

How could the mortgage interest deduction change under the current proposal in Washington?

A proposal put forth by a bipartisan group of senators - known as the Gang of Six - would lower the cap on eligible mortgages to $500,000. Second homes would no longer be eligible either. The idea is to restrict the use of tax breaks by wealthier households.

As the proposal stands, the change would apply to both new and existing mortgages, according to Jackie Perlman, a senior analyst for the Tax Institute at H&R Block.

Candice Choi writes for the Associated Press.