This piece was originally published on December 9, 2020, and was updated on January 3, 2023.
Homeownership isn’t cheap. There’s the actual cost of the place, your monthly mortgage payments, home insurance, heating and more. These are some of the most obvious costs, but there are some other housing costs that aren’t quite as obvious – and they’re not small!
One cost, often overlooked by both first-time homebuyers and seasoned homeowners, is your monthly share of your property tax bill. Most of the time, your lender will collect property tax in your mortgage payment, then pay your municipality on your behalf. However, there are some times when this is not ideal. Read on to learn when you pay your property taxes through your mortgage.
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What are property taxes?
Property taxes are fees collected from homeowners by your local council or city. These taxes fund essential services like garbage collection, snow clearing and your local fire and police departments. Are school taxes included in your mortgage property taxes? Sometimes – Toronto, for example, has a specific line item in their municipal tax for schools.
Property taxes are calculated as a percentage of your home’s assessed value. They’re paid on a quarterly, semi-annual or annual basis, depending on the municipality. Your municipality may also break your property taxes down into several different rates. For example, Toronto breaks property taxes down into three parts: city tax, education tax and the city building fund.
Here’s an example of the annual property tax you might pay on a home with an assessed value of $400,000 in Toronto.
The exact of property tax you owe will fluctuate based on your home’s value (which varies) and the municipality’s tax rate.
How to pay your property taxes
There are two ways you can pay property taxes. First, you could pay your property taxes directly to your city. These taxes probably won’t be due every month, so you should include them in your budget. This will keep you from being caught without the cash to pay them.
The second option is to have your lender collect a portion of your property taxes from you every month. Your lender will collect this with your monthly mortgage payment. It will then give your property tax payment to the municipality on your behalf. If you already own a home, ask your lender if your mortgage payment includes property taxes.
Pay your monthly real estate taxes through your mortgage
If everyone had the two options above, most people would probably opt to pay themselves. This would let them put the money in a high-interest savings account throughout the year, then earn travel rewards points or cash back when making the payment. Unfortunately, this isn’t an option for many homebuyers due to the restrictions most lenders place on this option.
If you have 20% equity or less in your home (for example, if you bought a home with a 5% down payment) or are a first-time homebuyer, your lender will likely require that they collect property taxes on your behalf. This is because not paying your property taxes is very bad news for your lender.
If you were to not pay your property tax, the city would place a lien on your property. A lien is a legal claim against property – in this case, the city would be able to claim your unpaid taxes against your home if you were to file for bankruptcy. Here’s the trouble for your lender: If you did file for bankruptcy, the lien would supersede your mortgage debt. So, to reduce the risk of the lender not getting their full investment back, they insist that ‘higher risk’ borrowers pay property taxes through them.
If you have a significant percentage of equity in your home, or if you are buying a rental property, you can ask if property taxes are included in your mortgage, and ask to pay separately.
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How your lender pays your property taxes
The good news is that having your lender pay your property taxes is easy and straightforward. You probably won’t even notice them doing it. To pay your property taxes, your lender estimates your annual property tax payment. The estimate is based on previous year’s property taxes, your home’s most recent assessment, and an extra percentage to account for property assessment fluctuations and tax hikes.
Your lender will then take this estimate and divide it by the number of mortgage payments you’ll make in a year. It will collect that amount on top of your monthly mortgage payment. For example, if your lender estimates you’ll pay $2,500 in property taxes in a year, and you make your mortgage payments monthly, your lender will collect an extra $208.33 ($2,500 / 12 = $208.33) each month.
When the money is collected, your lender holds it in an escrow account until the property taxes are due. If there is extra left in the account after the property taxes are paid, your monthly payment in the next year will be revised to compensate.
Should you pay property taxes through your mortgage?
If paying your property taxes yourself is an option for you, that doesn’t always mean you should do it. Here’s what to consider when deciding whether to pay your property taxes through your lender.
- Easy: Letting your lender collect and pay your property taxes is the easiest way to ensure they’re paid on time. You don’t have to worry about remembering to make your payment, which may only come once or twice a year.
- Better budgeting: Your lender will estimate your property taxes and add that amount to the sum withdrawn from your account as your mortgage payment, which makes it easy to budget for them.
- More expensive: Lenders usually estimate your property tax bill and then add a cushion just in case. As a result, you’ll pay more to your lender than your final property tax bill (although any over-payment will discount future payments).
- Missing rewards: Some municipalities let you pay your property taxes via credit card, and if you have a rewards card, you could earn points or cash back. Letting your lender pay your bills on your behalf means you’ll miss out on potential rewards.
- Missing interest: When your lender collects your property tax, they hold it in escrow until the payment is due to your city. While the money is being held, it earns interest, but the rates aren’t usually as good as the best high-interest savings accounts, so you are missing out on extra interest you could be earning.
Property taxes for first-time homebuyers
In most cases, if you’re a first-time homebuyer, your lender is going to require that you pay your property taxes through your mortgage. There are two primary reasons for this. First, if you have a down payment of less than 20%, you won’t have enough equity in your home for your lender to consider allowing you to pay your property taxes yourself. Most lenders require you to have 20% equity or more.
Some lenders also require you to pay your property tax through your mortgage if you are a first-time homebuyer. The logic behind this decision is that because you are a new homeowner, you may not be familiar with when property taxes are due, and your lender doesn’t want to take the chance that your city will put a lien on your home.
The bottom line
Paying your property taxes through your mortgage is an investment in your property’s future. Your lender knows this, which is why they will often insist that you go this route. Sure, it’s not strictly the best way to earn interest or rewards on that money, but it’s one less thing for you to worry about when you take your first steps into homeownership.