We’re constantly told ours is an ownership society in which owning a home is the foundation of household wealth. However, if we understand property taxes as a “lease from the local government for the right to gamble on another housing bubble arising,” then we see “ownership” in a different light.
The concept of ownership may appear straightforward, but consider these questions:
- If the house is mortgaged, what does the homeowner “own” when the bank has the senior claim to the property?
- If the homeowner owes local government $13,000 a year in property taxes, what does the homeowner “own” once they pay $260,000 in property taxes over 20 years?
The answer to the first question: the homeowner only “owns” the homeowners’ equity, the market value of the home minus the the mortgage and closing costs.
In a housing bubble, homeowners’ equity can soar as the skyrocketing value accrues to the homeowner, as the mortgage is fixed (in conventional mortgages).
But when bubbles pop and housing prices return to reality-based valuations, the declines also accrue to the homeowner’s equity.
If the price declines below the mortgage due the lender, the homeowners’ equity vanishes and the property is underwater. The property may still be worth, say, $400,000, but if the mortgage is $400,000, then the owner owns nothing but the promise to pay the mortgage and property taxes, and the right to claim a tax deduction for the mortgage interest paid.
To answer the second question, let’s consider an example: In areas with high property taxes annual bills in excess of $10,000 annually are not uncommon. If we take $13,000 annually as a typical total property tax in these areas (property taxes can include school taxes, library taxes, and a host of special assessments on top of the “official” base rate), the homeowner “owns” the obligation to pay local tax authorities $130,000 per decade for the right to “own” the house.
In states without Prop 13-type limits on how much property taxes can be raised, there is no guarantee that property taxes won’t jump higher in a decade, but for the sake of simplicity, let’s assume the rate is unchanged.
In 20 years of ownership, the homeowner will pay $260,000 in property taxes. Let’s compare that with the rise in their homeowners’ equity.
Since home values are high in high-tax regions, let’s assume a $400,000 purchase price with an $80,000 down payment and a conventional 4% 30-year mortgage of $320,000.
In 20 years of mortgage and tax payments, the homeowners paid about $197,500 in tax-deductible interest to the bank, and about $170,000 in mortgage principle, leaving them total homeowner’s equity of the $80,000 down payment and the $170,000 in principle, or a total of $250,000.
Since they paid $260,000 in property taxes in the period, have they gained anything? If we look at the property as merely leased from the local government for the annual fee of $13,000, then was “ownership” a good deal for the local government or for the homeowner? If the homeowner subtracts the lease fee (i.e., property taxes) from their equity, they are underwater by $10,000.
The real estate industry answer is that “ownership” is great because the skyrocketing appreciation accrues to the homeowner. If the house doubles in value from $400,000 to $800,000 in a decade, who cares about the $130,000 in property taxes paid? If we subtract this $130,000 lease fee, the homeowner would still pocket a hefty profit: $800,000 sales price minus the $400,000 purchase price, the $130,000 in property taxes, the costs of 10 years of maintaining the home and the selling commission and closing fees.
So in effect, anyone “owning” a home with high property taxes is leasing the property from the local government for the right to gamble that a new housing bubble is underway.
But, of course, real estate doesn’t always go up. Overseas buyers can vanish, mortgages rates can click higher despite central bank manipulation, and the economy can tank, causing household income to crater and home buyers to dry up.
The home “ownership” gamble is a big loser if real estate declines over 20 years. If our example property declines in value from $400,000 to $300,000 in 20 years, instead of doubling — or if property taxes rise another $4,000 a year as local governments demand their pound of flesh to cover rising pension costs — then the net equity of the “owner” becomes a $110,000 loss.
The conventional response to this “ownership” gamble is that renters have no upside. But this is not true. Renters can leave for cheaper regions without losing equity or having to wait for their house to sell. Renters can also negotiate lower rent somewhere else.
If we understand property taxes as a lease from the local government for the right to gamble on another housing bubble arising, then we see home “ownership” in a different light.
As the saying goes, buyer beware, especially if there’s no limit on how high desperate local governments can jack up their property taxes.
Photo Credit: Phil Sexton
You are absolutely correct. I live in New Jersey. I have always thought myself financially savvy, but because of property taxes the biggest financial mistake I made was buying a home. I realized this 25 years ago when they doubled my property taxes from one year to the next the first time and than again recently. In my personal case after running the numbers I have lost over a 100,000 dollars then what I would have paid if I had just rented. I hope to move out of Jersey soon, but will never buy again. It is really sad that you can never truly own your own home.
I agree, Don. Frankly, if more people understood that they can never truly own their own home — even after paying off the mortgage — there would be a lot fewer homeowners.
Us homeowners are all just one or two missed property tax payments away from losing our residences — which makes everyone very vulnerable to rising taxes. It’s also one more reason for taxpayers to resist the almost continuous call for higher property taxes from the public school unions.
The funny thing about the constant calls for higher property taxes by the public school unions (our taxes have just about tripled in 20 years, and the median teacher pay far exceeds the income of many homeowners) is that the local education bureaucracy constantly claims that we must continue this mad cost spiral to maintain our district standards–and our property values.
When ordinary average-size homes have taxes well into the mid-teens, that seems more like a threat to our property values and our financial well-being.
I completely agree, Ellis. And it seems like the more money the schools extract from the local community via property taxes, the worse things get.
Correct me if I’m wrong, but wouldn’t rent go up if property taxes went up on the owner of the rental. Yes they’d have to wait for the lease to be up to raise the rent, and if competition for renters is great it could be tough to raise rates. But what if there is a shortage of rental properties and they could easily raise rates? With a paid for house you pretty much know how much taxes, repairs, and insurance is going to cost month to month. Of course taxes could be raised and that could hurt if your on a limited income.
Most property taxes are based on the value of the house. So to keep that to a minimum, buy only as much house as you truly need. A smaller house also cost less to heat and repair. Choosing where you live also plays a big part in property taxes.
In the end it cost “X” amount of dollars to live and I doubt over the long term renting verses owning would be much different in cost. Like everything else it really depends on each household and their priorities.
You can’t compare apples to zeros.
Renting doesn’t stand on a pedestal immune from property taxes. Property taxes are baked into the cost of renting …. whether you like it or not.
Also, don’t compare a 1000sqft apartment rent to a 2000sqft home purchase.
If you compare apples to apples, then what does not work for you when it comes to owning a home (i.e. additional cost of property taxes) also won’t work for you when it comes to renting.
Yep. Planning to sell the home soon. Full time travel trailer Nomad. My rent will be minimal. Less is really more. My property taxes alone are currently $50 per day on the house. To each their own.