How Property Taxes Can Make or Break Home Affordability

Property taxes can make or break home affordability. Often overlooked or misunderstood, they can impact your monthly mortgage payment and long-term financial planning.

These are the taxes you pay for owning a home, not the tax on the profit you may eventually pay when selling.

Here’s what to know about property taxes.

1. Property Taxes Can Diminish Or Increase Your Maximum Home Price

When determining if you can afford a home, look beyond the purchase price and monthly principal and interest payment. Costs like insurance, HOA dues, and property taxes can make a home more expensive on a monthly basis than it initially seems. But while insurance and HOA fees are relatively easy to figure out, property taxes can vary wildly.

Your mortgage lender or servicer typically requires you to pay 1/12 of the annual amount along with your mortgage payment each month. It then pays the local jurisdiction for you. You can generally think of property taxes, then, as a monthly expense. For example, a $3,000 annual tax bill means $250 per month added to your principal and interest mortgage payment.

This is why it’s not a good idea to judge home affordability by the mortgage payment only.

The difference between a home with $3,000 or $5,000 annual tax costs is $167 per month. You could spend about $25,000 more on the house with lower property taxes and have the same monthly payment.

Homebuyers should shop for low property taxes as much or more than an open-layout living space or granite countertops.

2. Know How Property Taxes are Calculated

Property taxes are based on a percentage of the home’s assessed value. But the exact percentage is variable, and the value is determined by local government appraisers, not what you paid for the home or what your mortgage appraiser said it was worth.

Property tax rates are typically expressed as a percentage or millage rate (amount per $1,000 of assessed value). For example, a house assessed at $400,000 with a 1.25% tax rate would have an annual tax bill of $5,000.

However, it’s often more complicated, as most homes are part of multiple districts all with varying millage rates. In many areas, it is not uncommon to have over ten different taxing authorities who get paid, each charging a different percentage. Additional fees for services like waste collection, street lights, or stormwater management may also apply. And if your home is in a special taxing area like a Community Development District (CDD), more fees could be involved.

If you qualify for a certain monthly payment based on an average tax rate and the property you are interested in has higher taxes than expected, you may no longer be able to afford it, even if it was technically within your original price range.

3. How to Find Property Taxes on the Home You’re Interested In

Before making an offer on a home, know the property tax rate. This information is often listed online with the home or you can find it in public records like the county taxing authority’s website. Your real estate agent can also help.

But it’s more important to estimate what your future tax rate may be. Be cautious when looking at the current owner's tax bill, as it may not reflect what you’ll pay after buying the home. If it seems too low, it may be because the current owner is on a discounted plan or exemption. Confirm what it will actually be once you own the property.

When qualifying for a loan, lenders typically use the current tax rate to calculate your monthly payment. This can help you qualify if the taxes are low, but if the lender thinks it's too low, they may estimate a higher tax rate to ensure you still qualify. Confirm with your mortgage officer which method they’ll use, and have them run the numbers for your monthly payment before submitting an offer so you can avoid surprises.

4. How Property Taxes Rise Over Time

Property taxes rarely stay the same. They usually increase annually and, unless you directly intervene, they are not likely to go down.

The most common reason for property taxes to increase is because the value of your home has increased. But taxes can also rise due to inflation, significant home improvements like adding a pool or expanding square footage, or as local governments need more money to fund schools, roads, and public services. Even if your home’s value hasn’t risen dramatically, the tax rate might increase, so always leave room in your budget for a tax increase.

Some states have caps that limit how much property taxes can rise each year, but these may not always apply. Knowing your local tax laws can help you plan for future tax increases.

5. Watch Out for These “Gotchas” with Property Taxes

While property taxes are generally straightforward, some "gotchas" can catch buyers off guard. Here are a few to watch for:

• Older Property Values: In many places, property taxes are based on home values from one or two years ago. If values in your area have risen rapidly, the tax bill may jump when reassessed. This is especially true if you buy a flipped home where the old taxes reflect the pre-updated value.

• Exemptions: The current owner may have property tax exemptions that are reducing their taxes but that won’t transfer to you. Seniors, widows/widowers, people with major disabilities, and veterans may receive a discount on their taxes. If the current tax rate seems too good to be true, make sure you do some research on how much it will increase once you become the owner.

• Reassessments: In some states, like Florida, property taxes are reassessed when the property is sold and may have been capped at an artificially low annual increase due to things like a Homestead exemption. When the property is sold and the value is reassessed, you’ll be paying taxes based on the home’s current market value, not the previous owner's lower rate from years ago.

• Neighborhood Variances: Property taxes can vary significantly by neighborhood, even within the same city. In places like Chicago, differences in neighborhood tax rates can add thousands of dollars a year to your bill. Two similarly priced homes in different neighborhoods could have vastly different tax bills, impacting overall affordability. So make sure you do your due diligence on an area’s tax rate before starting to look for homes.

• Community Development Districts (CDDs): Community Development Districts (CDDs), also known as Municipal Utility Districts or Special Improvement Districts, let developers fund infrastructure like roads and utilities without having to pay for them directly. This reduces the initial cost of the homes but adds an additional fee to each property for 20 to 30 years. CDD fees are paid in addition to your regular property taxes, so confirm if the home you are interested in is in one of these areas.

6. Other Things to Know About Property Taxes

• Homestead Exemptions: Some states offer a homestead exemption for primary residences, reducing the taxable amount and sometimes offering other benefits like protecting your home from creditors. Check with your local tax authority to see if you qualify.

• Tax Appeals: If you believe your home has been over-assessed, you can appeal the assessment to lower your tax bill. This can be a time-consuming process but could save you money in the long term. If your property is recorded as bigger than it is or with upgrades or additions you don’t have, you can provide information to correct the discrepancy and have your property’s value reassessed.

• Escrow Accounts: Most lenders require homeowners to set up an escrow account. You can think of an escrow account as a holding account from which property taxes are paid when due. This ensures that when taxes come due, you won’t be caught off guard with a large, unexpected expense. But if you pay your first year’s escrow based on the last owner’s tax rate and the taxes go up, you will be responsible for making up the difference at the end of your first year owning the home. Your monthly payment will also increase as the new tax rate is calculated into your monthly payment. Do not buy a home at the top of your monthly budget as the payment will increase annually due to property taxes and insurance.

• Non-Payment Consequences: Failing to pay property taxes can result in penalties, interest, or even foreclosure. Even if you can opt out of having an escrow account, it is wise to keep one so that your taxes get paid on time every year.

Don’t Panic, Just Be Prepared

Taxes of any kind often seem daunting. But property taxes are an essential part of homeownership. While they can be complex and unpredictable, understanding how they affect affordability, how they may rise over time, and what hidden "gotchas" to look out for will help you make informed decisions. Be proactive about researching property taxes before buying a home, and work with your real estate agent or mortgage loan officer to ensure there are no surprises when the tax bill arrives.