A: You’ve asked some important questions, although we think you might be a bit confused about how your real estate tax and mortgage escrow accounts work.
Let’s start with a basic fact: Whether you carry a mortgage on your property has no impact on what you pay in real estate taxes. Your real estate taxes should be based on the actual value of the home or what your local taxing authority believes your home is worth.
Let’s say you purchased your home for $300,000. The taxing authority might base your real estate taxes on your purchase price or may have some other formula for determining the value of your home. Once it has determined that value, the taxing authority sets the amount of taxes you must pay based on a complicated formula. For our example, if the local taxing body says that your taxes are $3,000 per year, that’s the amount you are legally obligated to pay, regardless of whether you are currently paying off a mortgage.
For most homeowners with a mortgage, the lender requires the homeowner to pay monthly into escrow a sum equal to (or a little higher) than the expected amount of real estate taxes and the current homeowner insurance premium. If your real estate property tax bill is $3,000 per year, the lender will set the monthly amount you pay into the escrow account at $250. If your homeowners insurance policy is $1,200 per year, the lender will want you to pay an additional $100 per month to cover future insurance premiums. In addition, the lender may require you to put in an additional amount, typically limited to two months’ worth of insurance premiums and your total real estate tax bill, in case the bills come in higher than expected.
Whatever the sums are, they’re added to your monthly mortgage payment. When the lender’s servicer receives the payments, the amount due to the tax and insurance escrow are separated out and when those bills come due, the lender will pay them. The primary reason your lender holds these funds is to make sure these two bills are paid on time so the insurance policy doesn’t lapse and your home isn’t sold for back taxes.
Having said that, when you pay off your mortgage, your lender no longer has the obligation to pay your real estate taxes and homeowners insurance premium. From the day you pay off your loan, you must take on the obligation to pay these bills yourself — on time and in full.
If it’s too much to write those checks once or twice a year, when they come due, you can set up your own escrow account, and deposit one-twelfth of the amount due each month into the account. Since your mortgage will be paid off, it will hopefully be easier to come up with the funds, and then remember to pay the bill. (Check with your tax assessor’s office to make sure your home address is on the tax bill, so you are sure to receive it.)
The way real estate usually works, as you pay down your mortgage, your real estate tax bill will continue to rise. Recently, we found a tax bill from around 25 years ago that was about one-fifth of our current tax bill. Hopefully, your income over the decades will continue to increase so that paying a heftier tax bill won’t be too much of a burden.
Ilyce Glink is the author of “100 Questions Every First-Time Home Buyer Should Ask” (Fourth Edition). She is also the CEO of Best Money Moves, an app that employers provide to employees to measure and dial down financial stress. Samuel J. Tamkin is a Chicago-based real estate attorney. Contact them through her website, ThinkGlink.com.
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