438 Chapter 10 Consumer Mathematics
rates can vary dramatically from one state to another, and even from one community to
another. The real property tax rate in a given community will depend on the overall level
of government spending and taxation, the tax structure (in some areas these taxes are the
main source of tax revenue, while in others the government may collect more revenue from
sales or income taxes), and the overall tax base. However, whether high or low, these taxes
cannot be ignored in considering the cost of owning property.
What happens if you don’t pay your property taxes? The short answer to this ques-
tion is this: the government takes your property. Of course, this won’t normally happen
immediately. If you happen to be a month or two late with a payment, you may be hit
with some late fees, but matters usually have to get much further out of hand before you
would face a tax foreclosure. In most cases the government will make numerous attempts
to collect before resorting to seizing the property. The exact process and procedures for
this vary from one jurisdiction to another, but whatever the details may be, in the long
run, if you don’t pay, it’s taken away. (Usually once seized, the property is sold at a tax
auction.)
Of course, your mortgage lender does not want to see this happen. It is incredibly
unlikely that you would keep on making your mortgage payments on a property that has
been seized for taxes, and it is unlikely that the lender will be able recover the amount you
owe from such a property after the government has recovered the taxes owed. Again, the
details of how this all plays out would depend on the specific situation and jurisdiction. But
while the specific details might differ, one thing is certain: it will be a mess that the lender
would just as soon avoid.
To ensure that your taxes are paid as they should be, lenders often require an escrow
account for real estate taxes. An escrow account is a type of bank account into which you
make monthly payments to build up the amount needed to pay your real estate taxes when
they come due. The money in the account is yours, and you may earn a bit of interest on
it, but the account is controlled by the mortgage lender. Each month, when you make your
mortgage payment, you also pay into your escrow account. The amount of each payment
is typically 1/12 of the expected property tax for the year. So if, for example, the taxes
on your property are expected to be $3,000 for the year, each month you would send
$3,000/12 $250 with your mortgage payment, as shown here.You Escrow Government$250 monthly $3,000 annuallyOf course, the actual tax bill will seldom come out to be exactly the amount expected, and
so when the actual bill arrives, you may have to fork over some extra money if the bill is
higher (or get a refund if it is lower). However, any difference will likely be small, and so
the escrow account will still have fulfilled its purpose of making sure that enough money
is set aside so that paying the taxes isn’t a problem.
Mortgage lenders do not always require an escrow account, and are usually more will-
ing to waive one for borrowers who make a large down payment (someone who has a large
amount of money invested in the property is probably less likely to let the tax situation get
out of hand). However, even borrowers who could get out of having an escrow account
often prefer to have one, finding monthly escrow payments easier to swallow than one
large annual tax payment.
Escrow may also be required for homeowners’ insurance premiums. Suppose that your
house is destroyed in a fire, and you have either chosen not to carry any insurance or
neglected to pay your premiums. Insurance would have covered the loss and provided
money to pay off the mortgage or rebuild the property, but without it you’d be stuck still
owing the mortgage on a property that has been destroyed. Of course, being an honest
person you would no doubt honor your obligations and keep on making the payments.
Mortgage lenders are concerned, though, that some people might just be tempted to stop
making their payments and leave the lender to foreclose on a smoldering pile of ashes. To
avoid this possibility, lenders want to be sure that those insurance premiums are paid, and