Let’s face it: The pleasures of homeownership are not exactly synonymous with the payment of property taxes. In general, taxes are looked upon by many people as an undesirable—but wholly necessary—aspect of modern life of which the less said, the better.
While that might be true, property taxes have real-life consequences and can hugely impact your personal financial situation, especially in states with high rates. How much is property tax where you live anyway? Are property taxes included in mortgage payments? Let’s discuss what property taxes are, how they work, how much they cost and what they pay for.
A property tax is what it sounds like — a tax paid on a residential or commercial property owned by individuals like you or a legal entity. The rate is determined by your local government and is based on many factors. We’ll talk more about how to calculate property tax later. Since the tax rate is determined based on your local government, it varies across states and even across zip codes!
Take a state like New Jersey where homeowners pay an average property tax rate of 2.47% for 2021. On a $327,700 house (the median home price for Q1 2021 in NJ) that means $675 per month and $8,108 per year in property taxes.
On the other end of the spectrum, there are states like Alabama where average property tax on homeowners is 0.42%. With median property value at $137,200, this means Alabamians pay an average annual property tax of $572. A relative bargain.
Despite the many dissimilarities between New Jersey and Alabama, it’s still somewhat shocking to see a difference in annual property taxes to the tune of $7,500. It makes you think: What exactly goes into determining property taxes and where does the money you pay ultimately go? You may be surprised to learn how your property taxes benefit your community in a variety of ways.
While tax rates can change dramatically from state to state and even within each state, property taxes themselves are generally used to fund the following services regardless of location. We refer to them as the “Six S’s”:
Out of all the uses for property taxes, the one that homeowners are most aware of has to do with funding public schools. For at least 100 years, state and local municipalities across the country have used revenue from property taxes to help build and maintain schools and pay teacher salaries. Property taxes have proven to be an invaluable tool to meet the educational promises made to U.S. children, especially those in underserved or poorer communities.
While that still stands true today, and no state has fully abandoned property taxes, some states like Indiana and Michigan are shifting toward a model of state taxes to provide public school funding. Other states like California are looking into putting limits on local property tax growth. Clearly, there is a healthy national debate on the issue of how to calculate property tax. Policy makers continue to try to balance educational concerns with fair taxation.
When we say “safety” we mean the individuals who make our communities safe through their tireless work on the front lines. Property taxes help finance the salaries and supplies for firefighters, police, EMTs and a range of public safety workers. Beyond these essential institutions, property taxes also provide the funds necessary for legal payouts for misconduct, personal injury lawsuits, etc.
Public parks don’t maintain themselves. It takes funds from federal, state or private donors to ensure your local ball field, lakeside jogging path and nature preserve is taken care of. And not just maintained — many of these recreational sites require funds to be constructed. While property taxes are just one source of revenue for all this, they play an important role.
While debates on infrastructure consume politicians in Washington, D.C., back home in American communities — rural, suburban and in cities — roads still need to be built, legislation or not. One important contribution to the construction and maintenance of roads is tax revenue generated from property taxes.
Your monthly tax bill is likely itemized into sub categories of fees pertaining to trash collection, street cleaning, and sewer and storm-water management. While some don’t consider these property taxes, per se, these fees are levied only on homeowners so in effect they are a type of property tax that contributes to a clean, functioning community.
Property taxes fund libraries and many social services on the local level. For example, the health department and the animal shelter are sometimes funded by property taxes.
You understand what property taxes pay for — now, exactly how does property tax work? Let’s discuss when taxes are due, how to pay them and what they cost.
The due date of your property tax payments depends on which state you reside in. If you live in California, you can expect some differences from the rules in Illinois. Here, in Illinois, the due dates in most counties are set for June 1st and September 1st. This can vary, so it’s best to research the guidelines based on your county.
In some cases, bills are sent out late. The government adjusts expectations if the delay is their fault. In these cases, when are property taxes due? Your first tax payment is due 30 days after the date listed on your bill. If, for some reason, you’re unable to make that payment date due to it arriving so late, you should contact the billing department of your local government.
While not all types of loans require lenders to include property taxes in your monthly mortgage payments, there are some types that do. One example is the FHA mortgage. This type of loan lumps property tax payments into the mortgage payments you pay each month. Some lenders do often charge you more than the expected property tax, just in case you end up owing more than originally calculated. Of course, if you overpay, the lender will refund you. However, if you underpay, you will have to make additional payments.
How does it work if your property taxes are included in your mortgage? Well, the lender deposits any property taxes into escrow. This is an account that your lender uses to collect and store your taxes. Then, when the county requires payment, your lender pays your property taxes out of the escrow account.
Don’t think this removes the responsibility from you completely. You should still be checking every month for a notice of receipt of payment from your local tax collectors. If you’re missing this, you need to take action and speak with the tax authority and your lender. While having property taxes included in your mortgage payment can be easier, it is still your responsibility to make sure your taxes are paid on time.
Again, this rate depends on your state and even your county. Let’s talk about the average rate for our state, Illinois. In Illinois, you can expect the second highest property taxes in the U.S. The average expected rate is 2.16% meaning that many residents can expect to pay upwards of $6,000 annually. Of course, this rate depends on many factors and your property taxes could be quite different from your neighbor’s, let alone a different county.
You might be wondering a bit more about how the rate itself is affected. At the time of purchase, borrowers are often looking more closely at their mortgage rate than they are the property taxes.
The thing is, knowledge around taxes can help you better understand your mortgage, as these taxes will likely be rolled into your monthly mortgage payment and held in escrow for the state to collect later. Additionally, most homeowners are curious — some are even downright perplexed — why rates not only vary from state to state but between zip codes. Let’s take a look at the main factors at play when it comes to property taxes:
State and local authorities collected $547 billion in property taxes in 2018. While the revenue total may seem staggering, it’s not collected equally across all homeowners. By examining average home prices in a larger context, we can better understand how rates are generated and how to calculate property tax.
Elected government officials determine property tax rates in a process called “assessing” property value, and it is done regularly to accurately maintain the local tax revenue. After they have set a tax rate, it is applied to the assessed value/fair market value of your home. Wealthy communities with higher average home values, for example, will pay more in property taxes even though the tax rate is the same for all residents in the district.
While property assessment is the key indicator of property tax, it doesn’t tell the full story. With each state relying on property taxes to fund public education to a different degree, states invariably rely on different formulas to generate the money they need. This makes it difficult to compare tax bases in all 50 states because it’s not an apples to apples comparison.
Additionally, many states and localities impose limits on how much taxes can rise year to year and also when properties change hands. Add to this all manner of deductions, exemptions and credits to lower tax liability, and you’re left with many different effective tax rates across states and local municipalities.
Interestingly, any home renovation or remodeling projects you undertake that result in a net increase in home value will undoubtedly yield a higher effective property tax rate (once assessed). There’s an odd irony that when you’re creating value, you’re taxed for it, but that’s the unique logic of property taxes. While most homeowners will gladly accept those conditions, it’s worth emphasizing to first-time renovators that value can come with a cost. Literally.
Depending on the scale of the weather event and the extent of damages it leaves in its wake, homeowners may be eligible for disaster relief funds. While the federal government often steps in when a disaster is raised to a state of emergency, it’s more typical for state and local governments to reach into their coffers and foot the bill. This can contribute to an increase in property taxes as a way to make up for the shortfall.
Good news: if you live in a state or community where the tourist economy is especially robust, you may see a positive impact on your property taxes. As another form of revenue, the taxes levied on tourists can help offset the need to increase property taxes. It may not reduce them outright, but tourist taxation can help stabilize property taxes, everything else being equal.
Homeowners aren’t alone in paying property taxes; businesses also make a healthy contribution. The more robust the business climate, the better the tax base and the less need for homeowners to be targeted as a way to increase local tax revenue. In case you’re wondering, businesses are assessed by local government much the way homeowners are: real estate value. In addition, they have to pay property taxes when buying or selling property. Depending on the locality, the responsible party for paying these taxes could be the seller, buyer or both.
If you’re looking at buying a new home, how much is property tax going to be? Taking into account all of the aforementioned factors, let’s look at some questions you should ask yourself when calculating property tax.
Although there are homeowners who find it difficult to say a kind word about property taxes, the truth is that they are vital to the ongoing health of any given community. Without property taxes, no public pool, no public library, no public school for the kids to attend.
While all taxes are part of a grand bargain with the government; what is particularly satisfying about paying property taxes is seeing the tangible results within your community. Paying your fair share really does have visible consequences. Furthermore, a community with excellent public services is generally a community with higher home values. In the end, property that reliably appreciates is something that trumps a small bump in property taxes any day of the week.
We do not provide tax advice. Please contact your tax advisor for any tax-related questions.
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