What are property taxes?

When you buy a house, there’s more to consider than just the number of bedrooms, the age of the roof and the asking price. You also need to look at how much property taxes are on the home and factor them into your budget.

Property taxes are critical to communities — they support local governments and account for 72% of local tax collections, according to TaxFoundation.org.

But property taxes are also important to you, as a homebuyer and future homeowner, because they directly affect the cost of owning a home. Plus, they can give you an indication of the services your municipality and county might offer to homeowners.

Let’s look at what property taxes are, how they work and why they’re an important component of homeownership.
What are property taxes?

Property tax is the annual amount property owners pay to their local government or municipal corporation. These taxes cover costs like police and fire service, the administration of public schools, road maintenance, library operations and much more.

Your local government assesses property tax based on tangible real estate property, including the land and home. Generally, the amount you’ll pay will be a percentage of your home’s value, which varies by area.

It’s important to understand how property taxes can affect your buying power and the homebuying process.

Typically, your lender will pay your property taxes from an escrow account as part of your monthly mortgage payment. Since the taxes are included with the mortgage payment, high property taxes could push your monthly payment higher than you anticipated.

Your buying power is limited by the maximum monthly mortgage payment you can afford, including the tax escrow, compared to your income and debts. If the property taxes account for a significant portion of the payment, it could negatively impact your buying power.

A mortgage calculator can help you get an idea of your monthly mortgage payment but it’s important to have a realistic idea of your likely interest rate when using a calculator. Credible can help you see your personalized rates in minutes.
  How do property taxes work?

Property taxes keep the wheels of government moving in your local area. But who decides the amount of property taxes you should pay, and how are they calculated?

Here are some answers to common questions about property taxes.
Who decides how much property taxes are?

Homeowners in all 50 states and the District of Columbia pay property taxes but they’re levied at the local level, not by federal or state governments. Instead, cities, counties and school districts across the country set their own rates.

Government assessors usually analyze the assessed value of a property to decide an appropriate property tax amount. No matter what type of home or property you own, you can expect to pay property taxes.
What’s a property tax assessment?

Property tax assessment determines the amount of property taxes you’ll pay. The assessment is a professional estimation of your property’s value, which is set by numerous factors, such as comparative data with similar homes in your neighborhood.

You can figure out the property tax amount of any location by looking at the "mill" — the amount of property taxes homeowners pay per thousand dollars of home value. To find out the millage rate in your area, contact your county assessor’s office.
How are property taxes calculated?

Local governments and municipalities calculate property taxes in various ways. The assessed value of your property for your taxes might match your home’s actual value, but that’s not always the case. Some local governments use a lower value for tax assessments.

Remember, property tax rates aren’t fixed; they fluctuate as home values rise and fall. And they can change for a number of other reasons — for example, if a local community needs to raise extra money for an important road project.
How do I pay my property taxes?

Generally, you’ll pay property taxes in one of two ways.

    You can submit your payment annually or every six months when you receive your tax bill.
    Your lender can require you to save money each month in an escrow account. The lender then uses the funds in the escrow account to pay the taxes on your behalf when they’re due. Your lender should send you a Form 1098 every year detailing your tax payments.

Why are property taxes important when I buy a home?

When you buy a home, the property taxes for the remainder of the year are due at closing. Whether you or the seller are responsible for paying for them depends on your purchase contract with the seller. You may be on the hook to pay property taxes at closing if you agree to it. Most transactions follow the pro-rating formula, meaning you’ll only be responsible for paying the property taxes for the portion of the year when you actually own the house.

Let’s look at an example of how pro-rating works. Let’s say you come to an agreement with a seller that each of you will pay a portion of the property tax at closing, which is July 14. The total annual property tax on the home is $4,800. Here’s how a prorated calculation might look for the buyer and seller at closing.

    First, divide the total annual property taxes by 12 months to determine a monthly tax amount: $4,800 / 12 = $400.
    Divide the monthly amount by 30 to determine a daily amount due: $400 / 30 = $13.33 per day.
    Determine the amount the seller owes: The seller is responsible for six months and 14 days: 6 x $400 = $2,400, $13.33 x 14 = $186.62. $2,400 + $186.62 equals a total seller tax amount due of $2,586.62.
    Determine the amount the buyer owes: The buyer is responsible for five months and 16 days: 5 x $400 = $2,000, $13.33 x 16 = $213.28. $2,000 + $213.28 equals a total buyer tax amount due of $2,213.28.

Typically, these calculations are the responsibility of your lender or title company. They’ll give you a document detailing the "cash due at closing" that outlines your property tax responsibilities and other costs.

 

 

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