To understand how real estate taxes affect mortgage affordability, let’s look at the qualification equation used by banks.
(Gross Monthly Income – Total of All Minimum Installment Loan Payments) x Gross Disposable Income Factor = Total Permissible Monthly Payment. Gross Monthly Income is the average amount of income the borrower earns per month before taxes. Total of All Minimum Installment Loan Payments is the sum of the minimum monthly payments on all the borrower’s credit cards, monthly car/truck payments, minimum personal loan payments and minimum student loan payments. In the mortgage industry, Gross Monthly Income minus Minimum Installment Loan Payment is called Gross Disposable Income.
The Mortgage Rate Factor is more mysterious than Gross Disposable Income. The mortgage rate factor is a percent of Gross Disposable Income that is set aside for housing and is permissible under a particular residential mortgage program. The gross disposable income factor for a conventional mortgage is typically between 43 and 46 percent (.43 to .46) depending on the program; while the gross disposable income factor on government guaranteed loans is usually a little higher, between 47 and 50.5 percent (.47 to .505) depending on the program.
To illustrate the mortgage qualification equation, let’s add some numbers to it rather than wordy descriptions. Robert earns $3000 per month before taxes from his job at ABC Corporation. He has four credit card payments, three with a minimum monthly payment of $50 per month and one with a minimum monthly payment of $150. Robert has no personal loans and no student loans. (Student loan debt may complicate the equation especially if the student loan is in forbearance. So, we will keep it simple and not use student loan debt.). He also has a truck payment of $550 per month. Robert decides that he will apply for a conventional mortgage with a gross disposable income factor of 45 percent.
Dropping in the numbers from the above fact pattern, the equation looks like this. ($3000 – $850) x .45 = $967.50. For the conventional mortgage program Robert choose, he can have a maximum mortgage payment of $967.50 which must include PITI. That means that under the conventional mortgage program selected , Robert can afford a home of about $149,000 at an interest rate of 5% with 20% ($29.800) down, yearly insurance expense of $900 per year or $75 per month and taxes of $2976 per year or $248 per month.
IT COULD BE BETTER
All things the same, if the real estate taxes were $1000 per year less, Robert could afford a $175,000 home. In contrast, if Robert decided to buy the same house with lower taxes, his monthly payment would be about $880.
THAT’S ABOUT $85 PER MONTH SAVINGS.
Why does reducing your taxes $1000 per year affect a monthly mortgage payment $84 per year when reducing the amount of a mortgage by a $1000 only lessen the monthly mortgage payment by $5 dollars per month? The answer is simple when you think about. The entire amount of your real estate taxes are paid every year. The $1000 reduction on your mortgage is reduced over the life of your mortgage, usually thirty years. Thus, a real estate tax reduce is a dollar for dollar reduction in your payment every month, while the the $1000 mortgage reduction is only a few dollars per month over the thirty year life of your mortgage.
Reducing your real estate taxes, when possible, can help make your home more affordable and put more cash into your pocket. To do that in Pennsylvania, you will most likely need to file a tax appeal.
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