What can cause your pre-approved mortgage to fail, last minute, in 2022? Property tax and interest rates.
If you are borrowing the full amount of your pre-approved mortgage, you need to check the total monthly cost of a property before you make an offer. Your lender pre-approved you based on a typical property tax and within the range of interest rates at the time you pre-approved. An increase in any of these can knock you out of the accepted loan-to-value ratios and void your pre-approval:
- A higher than typical interest rate
- A higher than typical property tax
- A higher than typical condo fee
In a recent “Scare the buyers” article in The Boston Globe, the reporter told a tale of would-be buyers who ran afoul of an interest rate increase. They lost the property they had an accepted offer on.
About those interest rates
Example 1: I ran a mortgage calculator to see what an $800,000 property will cost with a twenty percent down payment. I used these parameters: $6,000 a year property taxes, $2,500 a year property insurance.
At five percent, your cost is roughly $4150 a month. That doesn’t include that $160,000 for down payment nor the approximately $12,000 for closing, legal, and inspection fees.
At four and a half percent interest, it goes down to almost $3,950
At five and a half percent interest, it goes up to almost $4,350.
In some towns, you can buy an $800,000 property and have a $6000 annual tax bill. In other towns, that tax bill goes up to as much as $9000. Now, what will it cost, every month, if you have a $9000 a year tax bill?
Example 2: I ran a mortgage calculator to see what an $800,000 property will cost with a twenty percent down payment. I used these parameters: $9,000 a year property taxes, $2,500 a year property insurance.
At five percent, your cost is roughly $4,400 a month. That doesn’t include that $160,000 for down payment nor the approximately $12,000 for closing, legal, and inspection fees.
At four and a half percent interest, it goes down to almost $4,200.
At five and a half percent interest, it goes up to almost $5,000.
The Rent or Buy Question
If you are pre-approved for an $800,000 mortgage, what properties could you have bought in the past six months in our most popular towns: Arlington, Cambridge, Lexington, Malden, Medford, Melrose, Somerville, Watertown?
Closed in the past six months, for single family homes and condos in the price range of $780-820,000:
21 were two-bedroom properties.
42 were three-bedroom properties.
12 were four-bedroom properties.
1 had five or more bedrooms.
How many of you are paying more than $4000 a month for two or three bedroom rentals?
Conclusion: Buying is not about paying less, now. Buying is about building wealth (equity) while paying for your residence.
Now, about those taxes:
When we set up customized searches for our clients as they start their house hunting, we discuss the tax rates in the towns they are looking in. In some towns, you can pay a higher sale price, but because of the tax structure, it will cost less per month for it. Here is a recent example:
In 2022, one of our clients had this experience:
The clients made an offer on a property in Arlington at $710k. Taxes were $5900 per year. That offer did not win the bidding war.
Their next offer was accepted. It was in Cambridge for $790k. With taxes at $1500 per year (after exemption), their monthly cost was cheaper in Cambridge despite paying $80k more for the condo.
Every town and city creates a tax rate. This number is used to calculate property taxes. The residential tax rate times the assessment equals your annual taxes. Tax rates vary, quite a lot, from town to town.
The residential rates are lower where the municipality has a big commercial or business tax income. Also, large non-profits, like universities, pay in-lieu-of-taxes fees to the town or city. So, cities and towns that are rich can give their homeowners a break.
Here’s a map with tax rates in Massachusetts.
Why do your property taxes keep going up, when the tax rate has gone down or stayed the same?
For most of our clients in eastern Massachusetts, their property taxes went up for 2022. In many towns and cities, the tax rate stayed the same, or even went down. However, property taxes go up as the assessed value of the property goes up.
Property tax on real estate is calculated by the assessed value of the property times the municipal tax rate.
Most of the value of your property is the land. No matter how nice your house or condo might be, the land size and location have the biggest impact on your assessed value. If you own a property in an area where properties are selling for much more than they sold for last year, your property is considered more valuable than last year, whether you did anything to improve it or not. The location of the land makes it more valuable, since you could sell it for more now, if you chose to.
How close are assessed values to sales values?
Assessed values tend to be lower than actual sales values when the market is going up. There is a time-lag because the process of assessment is slow and involves large numbers of property. When property values are increasing, it takes the municipality time to catch up. More on assessment in this post by Jonathan Steinberg, MAA, MACR, is the Chief Assessor, Town of Westborough
What else affects the tax rate?
Special assessments/temporary tax increases: Some towns and cities create a temporary tax increase to pay for a big capital project – like a new high school.
Residential exemptions: A residential exemption is a tax break given to owner-occupied properties in a town or city. We see these tax breaks in towns and cities that have a solid tax base (so they can afford to give the break) and also have a significant number of investor landlords in town. Instead of increasing the taxes on landlord, the towns and cities reduce the taxes on owner-occupied properties.