The road to homeownership isn’t just about finding the perfect house and securing the right mortgage. It’s also about the ongoing financial responsibilities that come with it. One of the biggest, yet often overlooked, is property taxes. These annual payments can significantly impact a homeowner’s budget. While they might not be as visible as monthly mortgage payments, they can add up quickly and catch unprepared homeowners off guard.
As a mortgage professional, by proactively discussing property taxes with your clients, you can help them budget for annual tax payments, explore potential tax breaks, and minimize their overall tax burden. You can also help them understand how property taxes can impact their mortgage payments, especially if they opt for escrow accounts. Thus, by adding a focus on tax planning as a natural extension of your role, you can greatly simplify what can be a confusing aspect of homeownership for your clients.
What Are Property Taxes? A Quick Overview
Property taxes are essentially a fee that homeowners pay to their local government (typically county, city, and school districts) on a regular basis (usually once a year). These taxes are “levied on the value of “real property” (land and buildings, both residential and commercial) or personal property (business equipment, inventories, and noncommercial motor vehicles).” The revenue collected is used to fund local services such as public schools, fire departments, law enforcement, road maintenance, and community programs.
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These taxes date back to the colonial era, making property taxation one of the oldest forms of government funding in the country. Today, property taxes remain a crucial part of local government budgets, directly impacting the quality of life in the communities they support.
The amount of property taxes a homeowner owes depends on two main factors: property value (also known as “assessed value”) and the property tax rate (also known as “millage rate”). Property value is the value of a home as determined by the local government based on factors such as the location, size, and condition of the property. The property tax rate is the rate at which a property is taxed. It’s set by the local government and can vary widely from area to area.
How to Calculate the Property Tax Bill?
To calculate the annual property tax bill, the assessed value of the home is multiplied by the property tax rate. The resulting amount is what the homeowner owes annually.
It’s important to note that property taxes vary widely depending on the location and assessed value. Factors like local economic conditions, the quality of public schools, and the level of government spending can all influence property tax rates. For example, homes in densely populated urban areas or highly desirable school districts may have higher property taxes than those in rural areas. In addition, each state and local government has its own unique tax structure, which can lead to significant differences across the country.
For more information on property taxes by state and county, navigate here.
Understanding Escrow Accounts and Property Taxes
Property taxes can be a complex and time-consuming aspect of homeownership. Tracking due dates, calculating exact amounts, and ensuring timely payments can be a significant burden. That’s why many lenders and mortgage servicers require borrowers to set up escrow accounts to simplify the process and collect the correct amount on time. According to the Consumer Financial Protection Bureau (CFPB), “Escrow account means any account that a servicer establishes or controls on behalf of a borrower to pay taxes, insurance premiums (including flood insurance), or other charges with respect to a federally related mortgage loan, including charges that the borrower and servicer have voluntarily agreed that the servicer should collect and pay.”
When your client gets a mortgage, a lender or a mortgage servicer typically requires them to pay a portion of their estimated annual property tax bill each month. This money is deposited into the escrow account. As the tax bills come due, the lender or mortgage servicer pays them directly from the account on behalf of the homeowner.
Escrow Accounts: Things to Consider
Using escrow accounts greatly simplifies the payment process. Instead of making one large annual tax payment, a borrower can spread the cost over 12 monthly installments. Also, a lender or a mortgage servicer handles the timing and payment of the property taxes, reducing the risk of late fees and penalties. What is more, some lenders may be able to negotiate lower property tax rates with local authorities, which could save your client money.
On the other hand, escrow can be fraught with some issues like shortages and overages. If your client’s property taxes rise more than expected, their escrow account might not have enough funds to cover the bill, creating a shortfall that the homeowner must cover, often by increasing monthly payments. If your client’s property taxes are lower than estimated, their escrow account may have a surplus that the lender may refund or adjust on future payments.
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To avoid any surprises with the escrow account, it’s important for your client to keep an eye on their escrow account and make sure it’s properly funded. They should review their escrow statements annually to ensure that their payments are accurate and that their account is neither underfunded nor overfunded.
How to Help Clients Plan for Annual Tax Payments
So, how can you practically help your clients with effective tax payment planning? Here are some actionable tips for this.
Understanding Local Property Tax Laws
Start by familiarizing yourself with the local property tax laws in your area. Understanding the specific deadlines, penalties for late payments, and any recent changes can help you provide accurate information to your clients. You can check with local taxing authorities or use online resources like USA.gov, IRS, Tax Policy Center, etc., to stay updated.
Estimating Property Tax Payments
Once you have a good understanding of local tax laws, you can help your clients estimate their annual property tax bill. This can be done by multiplying the assessed value of their home by the local property tax rate. For an easier process and more accurate estimates, encourage your clients to use online property tax calculators (e.g., SmartAsset, Zillow, Casaplorer, Anytime Estimate) or consult with local tax assessors.
Educating Clients on Escrow Adjustments
As mentioned above, escrow accounts are subject to occasional adjustments due to fluctuations in tax rates and insurance costs. So, if your client has an escrow account, it’s important to prepare them for these potential changes. Encourage your clients to review their annual escrow statements carefully. If they notice a significant increase in their monthly payment, you can help them understand the reasons for the change and explore options to manage the increased cost.
Setting Aside Funds for Property Taxes
In some cases, escrow accounts may not be sufficient to cover the entire property tax bill. This can happen due to unexpected increases in property values or tax rates. Encourage your clients to set aside additional funds in a separate savings account to cover any potential shortfalls.
Dealing with Property Tax Increases
Property taxes are a significant expense for homeowners, and unfortunately, they can increase over time. It’s important to remember those hikes aren’t arbitrary. They often reflect underlying economic factors and local government needs. Explaining the reasons behind tax increases will help your clients prepare and feel confident in managing them. What’s more, the most common reasons are quite predictable factors. For example, because property taxes are calculated as a percentage of a home’s assessed value, when local property values rise, so do property taxes. Another factor influencing property taxes is local government budgets. If a municipality needs more revenue to fund schools, roads, or other public services, it may raise property taxes. Additionally, a booming local economy can drive up property values and, consequently, property taxes. This is particularly true in areas with high demand for residential and commercial real estate.
By understanding these factors, your clients can anticipate and prepare for increases. To help them manage the financial impact, you can apply these strategies:
- Monitoring Property Assessments. Encourage your clients to keep an eye on their property’s assessed value. If they believe the assessment is inaccurate, they can appeal the valuation to the local property tax assessor.
- Staying Informed About Local Government Budgets. Keep up-to-date on local government budgets and spending plans. This information can help you anticipate potential tax increases and advise your clients accordingly.
- Exploring Tax Exemptions. Some jurisdictions offer property tax exemptions for specific groups, such as older citizens, veterans, or low-income homeowners. Advise your clients to research these programs and see if they qualify.
Property Tax Exemptions and Discounts
While rising taxes can add to an already heavy financial burden, the good news is that states and local governments often use “limits, exemptions, deductions, and credits to lower a real property’s taxable value or the taxpayer’s payment for some or all owners.” As a mortgage professional, you can play a vital role in helping your clients understand and take advantage of these opportunities. Some of the most common types of tax benefits include homestead, older citizen, veteran, and disability exemptions. Let’s take a closer look at each one.
Homestead Exemption
This is one of the most common exemptions, often reducing property taxes for primary residences. To qualify, homeowners typically need to live in the property as their primary residence.
For your reference: Homestead exemptions by state and territory
Older Citizen Exemptions
Many states offer property tax exemptions or discounts for older citizens, especially those on fixed incomes. Specific eligibility criteria vary by state.
For your reference: States with property tax exemptions for older citizens
Veteran’s Exemptions
Veterans may qualify for property tax exemptions or discounts, especially those with service-connected disabilities.
For your reference: Complete list of veteran property tax exemptions by state
Disability Exemptions
Individuals with disabilities may be eligible for property tax exemptions or discounts, depending on the severity of the disability and local regulations.
For your reference: More information for people with disabilities
To help your clients maximize their property tax savings, stay informed about the specific exemptions available in your clients’ jurisdictions. Local assessor’s offices are the best source for accurate and up-to-date information. Also, help your clients navigate the application process, which often involves providing documentation such as proof of residency, age, veteran status, or disability.
It’s important to note that exemptions may need to be renewed annually or periodically. For example, older citizen exemptions typically need renewal every few years to ensure eligibility. Keep your clients informed about deadlines and renewal requirements so that you can help them maintain their exemptions and avoid any unexpected tax increases.
When Property Taxes Are Not Escrowed: Managing Independent Payments
According to Bankrate, “If you’re obtaining a conventional mortgage — that is, one from a private bank or lender — an escrow account is often required with a down payment of less than the standard 20 percent, as is mortgage insurance. You often don’t have a choice if you’re getting a federally-backed loan, either. FHA loans and USDA loans require escrow accounts, though VA loans do not.” So, not all borrowers always have an escrow account set up. In addition, some investment properties or refinances do not require taxes to be escrowed. However, paying property taxes independently can be difficult. As a mortgage professional, you can provide some practical advice for your clients to help them manage their own tax payments.
Budgeting for Tax Payments
Encourage your clients to allocate a specific amount of their monthly budget to a dedicated property tax savings account. This proactive approach will ensure that they have sufficient funds to cover their annual tax bill.
Setting Reminders
Assist your clients in setting up a reminder system, whether it’s a calendar alert, a phone notification, or a dedicated financial app. This will help them stay on top of payment deadlines and avoid late fees.
Setting up Automated Payments
Suggest that clients set up automatic payments from their checking or savings accounts to the appropriate taxing authority. This eliminates the risk of forgetting a payment or miscalculating the amount.
By following these recommendations, you can reduce the stress of managing independent property tax payments and give your clients confidence in their financial planning.
How Property Taxes Affect Mortgage Affordability
It’s important to remember that property taxes, often overlooked in the initial excitement of homeownership, can significantly impact a borrower’s overall affordability. Because they are a part of mortgage payments, they add to your client’s monthly housing expenses. This can impact their budget and reduce their overall affordability. Higher property taxes can make it harder to afford a home in a particular area or limit the size or type of home they can buy. Property taxes are included in the calculation of a borrower’s debt-to-income ratio, which mortgage lenders use to assess a borrower’s ability to repay a loan. A higher property tax burden will result in a higher DTI ratio, which may limit the amount a borrower can qualify for.
Let’s say a borrower with a monthly income of $4,000 and a monthly debt payment of $500 is considering a home with a monthly mortgage payment of $1,500 and an estimated annual property tax bill of $3,600. This means the borrower would need to budget an additional $300 per month for property taxes, bringing their total monthly housing cost to $1,800. This could have a significant impact on their DTI ratio.
Given:
- Monthly income: $4,000
- Monthly mortgage payment (principal and interest): $1,500
- Monthly property tax payment: $3,600 / 12 = $300
- Monthly debt payments (excluding housing): $500
Calculating DTI:
($1,500 + $300 + $500) / $4,000 = 57.5%In this case, the $300 property tax payment directly increases the DTI ratio. A higher DTI ratio can make it more difficult for the borrower to qualify for a mortgage because lenders typically prefer lower DTI ratios.
The tax amount added to your client’s monthly expenses can push the DTI ratio closer to or even above acceptable limits for mortgage approval. Even if a borrower has a steady income and limited other debts, higher property taxes can restrict the mortgage amount they qualify for, as lenders see this as an added financial commitment that may strain their ability to make payments consistently. That’s why it’s essential to discuss property taxes with your clients early in the home-buying process, as taxes vary widely by location and property type and can substantially alter affordability. By accurately accounting for property taxes in DTI calculations, you can help your clients avoid surprises down the line and guide them toward homes that fit their true financial profile.
Supporting Clients Through Every Step of Property Taxes Planning
Remember, your clients’ road to homeownership doesn’t end at the closing table. They have a much longer way through the ongoing financial aspects of owning a home, including the often-overlooked yet impactful property taxes. And that’s where your role as a mortgage professional shouldn’t fade.
By familiarizing yourself with local tax laws and exemptions, you can identify potential savings and minimize your clients’ tax burden. Educate your clients about taking control of their finances by sharing budgeting strategies, setting up automatic payments, and advising them to set aside funds for annual tax bills. This proactive approach will reduce stress and ensure they’re ready for unexpected increases.
By incorporating property tax planning into your services, you’re not just helping your clients find a home, you’re setting them up for long-term financial success.
