When you are applying for a loan, there are many factors that are involved in determining what you qualify for. A lender looks at your debt to income ratio (DTI) to come up with a monthly payment that is allowable under their guidelines. A very simple way to think about this is that your money going out (debts) can only be 45% (ish) of your money coming in (income). This also includes your new mortgage payment, and this mortgage payment is your entire PITI payment - Principal, Interest, Taxes, and Insurance. Your property taxes will affect your overall purchase price because it has a major effect on the amount of your monthly payment.
Different areas have different property taxes
If you are looking to buy a house that costs $250,000, depending on where you are looking, the property taxes may actually price you out of the neighborhood. Property taxes are calculated on a percentage of the value of the property. In Texas, these property taxes could be 2.2% in one neighborhood, and 3.5% in a different neighborhood. On that $250,000 house, that is a difference of $3250 a year.
At 2.2% property tax rate, your property tax portion of your monthly PITI payment will be $458. At 3.5%, you property tax portion of your monthly PITI payment will be $729. That is a difference of $271.
If your DTI is close to that 45%, you may not qualify for a house that is in the 3.5% property tax area. You also may not be comfortable with a monthly payment that is $271 higher even though you can afford it.
Calculating the Property Tax Portion of Your Mortgage Payment
To calculate the Property Tax portion of your monthly PITI payment, you will first need to know the tax rate in the neighborhood. Your Realtor will be able to provide this to you based on the tax records. You will then need to know the assessed value of the home. This information is also on the tax records. Note that the assessed value of the home is the value that the tax appraisal district gives the home, not the price you pay for it, or even what it is worth. If this number is lower than what you are going to pay for the house, then that is great! You will pay less in taxes! If it is more, then you will need to protest your taxes when the time comes up and get this assessed value lowered.
From here, it is simple math: Multiply the tax rate by the assessed value to come up with the overall taxes for the year, then divide this number by 12 for the monthly payment of the taxes.
How this affects your home purchase price
When you are pre approved at the 45% DTI, you are given an allowable monthly payment. This monthly payment will include your property tax payment based on an average of the area you are shopping in. An experienced lender will err on the high side of the average just in case you end up looking in the higher taxed area.
So, in the example above, let’s say that your average tax rate in the area is 3%. If you are approved up to $250,000, then your monthly taxes can only be $625 a month. If your taxes come in at 3.5%, then the amount of house you can buy will come down, in this case by about $20,000. Likewise, if you end up in the area where your taxes are in the 2.5% range, then you will be able to purchase up to $270,000.
How do I determine the best course of action?
The best thing to do as you are home shopping is to pay attention to the property tax rate of each home you want to go see. Before you go out, take one home as an example and have your lender give you a property specific estimate. In fact, it would be a good idea to do this on a few homes that you are about to go see. Maybe one has a list price at $245,000 with a 3.2% tax rate, and another has a $250,000 list price with a 2.5% tax rate. You can compare these side by side to get a better idea of how much each house is going to cost you monthly. Keep in mind that the overall sales price will also affect your down payment, so you need to make sure you have enough cash in the bank if you are going to go higher. These are all discussions that you should have with both your Realtor and your Lender.
Before you make an offer on a home, it is in your best interests to have a property specific quote on the house you are going to make the offer on. It is also a good idea to go ahead and get an insurance quote as well. If you give the insurance quote info to your lender, they will be able to nail down what your payments are going to look like, probably within a few dollars.
When you are getting these quotes, always use the list price of the home as this will likely be the most you will pay for the property.
Pay Attention to the Details
The bottom line is to make sure you pay attention to all of the details when you are home shopping. Fortunately, you have a Realtor that will be able to help guide you through the process and make sure you are making the best decisions for you and your family.