'Fiscal Cliff' Deal Favors Housing Recovery

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The housing market is on firmer ground today, as two major tax provisions survived the "fiscal cliff." Congress did not touch the mortgage interest deduction, and it extended tax relief for one year on mortgage debt forgiveness.

"An extension of the tax break is positive for home values by reducing the number of foreclosures and helping more troubled borrowers stay in their homes," wrote Jaret Seiberg of Guggenheim Partners. "That means less supply on the market."

Under a law signed in 2007, debt relief on loan modifications, short sales, and foreclosures were no longer taxable; that break expired at the end of 2012. The fear was that if the tax break was not extended, home owners would not agree to short sales (when the home is sold for less than the value of the mortgage) because they would then face a tax bill. They would also not agree to principal reduction loan modifications, which have proven to be far more successful than other modifications that leave the principal balance as is.

Under the $25 billion mortgage servicing settlement, borrowers have received $6.3 billion in mortgage principal relief through September, according to the settlement's monitor, Joseph A. Smith, Jr. The average loan balance reduction, $150,000. Banks completed 13,351 principal reduction loan modifications in November alone, according to Amherst Securities Group, a 62 percent jump from September.

Short sales also surged toward the end of the year, thanks to streamlined procedures and a more aggressive stance by the big banks, again in part due to the mortgage servicing settlement. More than 98 thousand short sales were completed in the third quarter of 2012, according to RealtyTrac.

The "fiscal cliff" deal also allows borrowers to deduct the amount they pay for private mortgage insurance, which has become increasingly prevalent in today's tighter mortgage market.

(Read More: What's in the 'Fiscal Cliff' Bill Passed by Congress?)

All of the above will help to lower the number of foreclosures and support the slow rise in home prices. The number of homes in the so-called "shadow inventory" (properties that have seriously delinquent mortgages, are in foreclosure, or are owned by banks but not yet listed for sale) fell to 2.3 million in October, according to a new report from CoreLogic. That represents a seven-month supply at the current sales pace, and is a 12 percent drop from a year ago.

"We expect a gradual and progressive contraction in the shadow inventory in 2013 as investors continue to snap up foreclosed and REO properties and the broader recovery in housing market fundamentals takes hold," said Anand Nallathambi, president and CEO of CoreLogic in a release.

That would not have been the case, had tax relief on debt forgiveness in short sales and principal reduction modifications come to an end.

(Read More: Despite 'Cliff' Deal's Cuts, Your Taxes Are Going Up)

—By CNBC's Diana Olick; Follow her on Twitter @Diana_Olick or on Facebook at facebook.com/DianaOlickCNBC

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