Paying your property taxes through your mortgage can offer the convenience of one less bill to deal with each month. However, what is the real cost of this option and is it worth it for you?
Quick Property Tax Refresher
Property taxes are typically paid to your municipality on a quarterly, semi-annual or annual basis. The total taxes for the year are calculated based on your property’s assessment multiplied by the municipality’s current tax rate for your property type. The exact tax amount owed on your property will fluctuate from year-to-year as these two variables change.
Why the Bank Wants to Pay Your Property Taxes
If you are suddenly unable to make your payments, the municipality can place a lien on your property. If you were to file for bankruptcy, this lien can supersede the debt payments owing to the lender. Therefore, lenders reduce their risk of being second-in-line if you run into money troubles by handling the payments for you.
When Combined Property Tax and Mortgage Payments are Required
If you hold less than 20% of the property (LTV > 80%) or you are a first-time homebuyer, most lenders will require that you pay your property taxes through them, especially if they are offering competitive rates. Also, if you are purchasing a rental property then you should have invested at least 20% already, and will have more room to negotiate the flexibility of paying your own property taxes.
How the Bank Pays Your Property Taxes
Your bank simply estimates the total annual property tax payment then divides this amount by the number of mortgage payments you make each year and holds them in an escrow account until property taxes are due. Sounds simple enough, right?
However, lenders will often collect more than the estimated annual tax amount in order to cover any possible fluctuations in annual tax increases. Different municipalities also have different payment deadlines, and in order reduce the risk of getting caught without having enough cash to cover the payment, they will collect more per month than is necessary.
The opportunity costs associated with these payments and any surplus payments that the banks collect will be discussed in further detail below.
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Why Many Homeowners Use This System
Instead of budgeting for a large annual or semi-annual payment – or worse, being surprised by a large property tax payment – homeowners can pay monthly installments. For busy homeowners, this security may be worth the costs associated with this system.
The Costs of Combined Payments
There is an opportunity cost associated with any payments that are collected in advance of when the actual payment is due. Interest earned in one of these escrow accounts can be minimal and range from nothing to a rate similar to a basic savings account.
When the lender collects excess cash in order to cover any variables, they often continue to roll this surplus over to the following year as an additional safeguard. This surplus will eventually be paid back to the mortgage holder; however, the years it spent in escrow will have earned it little to no additional interest.
The first major cost is any lost investment income this money could earn at a higher rate of return with a different investment until the taxes are due. If the bank has not judged the payment schedule correctly or they have yet to collect enough in order to cover the costs for this year, they will lend you the necessary cash typically at the same rate as your current mortgage interest rate.
The second major cost is the unnecessary expense if you personally do have the funds to contribute to property taxes at the time they are due.
For the Average Investor or Homeowner
The typical finance theorist would state that any surplus cash not being used for property taxes should be invested into assets with greater returns. However, for the average person this cut and dry theory isn’t always feasible. What does make sense to most people is better cash flow.
If you are a homeowner or managing a rental property the surplus cash being rolled over in an escrow account each year could be better used to cover any unexpected expenses. This is doubly true if you are covering some of these expenses with credit cards or other debt because your surplus cash is out of reach.
Takeaways and Tips
Your lender is approaching your annual property tax payment as an investment, and you should too. If you feel comfortable budgeting for your property taxes each year then you can make significant reductions in unnecessary debt-related costs and increase your monthly cash flow with greater dividends and cash-on-hand.
- Follow the banks lead. What they are doing is smart; however, they are reducing their own risk and not just yours.
- Schedule property tax due dates. This way you are able to budget accordingly.
- Stay up-to-date with your current year’s assessment and municipal tax rates. (Each municipality includes property tax specifics on their website.)
Michael Rix is a co-founder of TurnKii, a Toronto-based company providing an all-in-one tool and service to support everyday landlords/real estate investors. TurnKii fills the void between the everyday hassles of being a landlord and the hiring of expensive property management. Landlords can now rely on TurnKii to manage tenants, complete physical maintenance, and track financial data all-in-one place.
Flickr: Grant MacDonald