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Is a 470k house in Mountainside cheaper than a 400k house in West Orange ?
I guess the headline gives it away. I was recently thinking about the cost of property taxes, and how these need to be taken into account when specifying a budget, especially shopping in different towns. I have some math in here, but I've sidelined it to footnotes, in the interests of readability.
First, there's the basic calculation -- you compare monthly payments on the two properties. Let's start with the following assumptions:
100k for a downpayment
5% interest rate annually compounded
2500/month budget for total payment
property tax 3% of value in WO, 1.27% in Mountainside
470K in Mountainside is cheaper than 400K in West Orange
A "how much can I afford" (1) calculation results in 386K for West Orange, 472K for Mountainside. The take home lesson -- those "cheap" houses in high tax towns might not be such a bargain after all. For each $100/month reduction in property taxes, you can have about $20k more house for the same monthly payment.
If your property taxes are eating you alive today, what will they do to you in 10 years ?
But there's more: your mortgage payment is fixed, while your tax payment grows. And not all towns taxes grow at the same rate. According to NJ by the numbers, West Orange's property taxes grew by 62.3% between 2000 and 2007, whereas Mountainside's grew by 48.9%. These work out to 6.9% and 5.6% continuously compounded (2).
Either way, your total payments will increase, but in a higher tax town which also has a higher rate of growth in tax revenue, they will increase at a faster rate.
Doing the math (3), the difference between monthly payments made by the WO home owner and the Mountainside home owned after 5, 10, 20 and 30 years is 234, 579, 1824, and 4469(!) dollars. One might question extrapolating out the difference in growth rates over 30 years, if we assume both grow at the same rate the difference is more like 150/350/1k/2k (a month!).
Property tax as confiscation of home equity
The next thing to analyze is, what does this tax growth do to your property values ? Assuming that a potential buyer is willing to pay the same monthly payment to live in each house, the tax advantage of the town with the lower taxes goes into home equity (e.g. plug the difference in monthly taxes into the how much can I afford formula). Assuming rates stay the same, this difference is 55k or 90k after 10 years (depending whether you assume that one towns taxes grow faster than the other), and a whopping 300k/700k after 30 years. Hence property taxes can be viewed as a confiscation of home equity. In some sense, you lose twice -- once in that you pay more property tax, and a second time, because your resale value suffers from the tax liability.
Footnotes/Math
(1) the how much can I afford calculation is given by solving for price for a given monthly payment, a given down payment, and A which is "the buying power of $1- a month" computed in the standard mortgage formula where:
monthly payment = A * ( price - down payment ) + monthly Property Tax Rate * price
(3) growth in monthly payment is: price * initial tax rate * (exp( tax growth rate * time ) - 1.0 ) / 12
e.g. for WO, we have 385k * 0.03 * (exp( 0.069 * 10 ) - 1 ) / 12 = $956 more in taxes after 10 years.
Last edited by elflord1973; 12-31-2009 at 05:03 PM..
Reason: subheadings added, some edits for clarity
You cannot leave taxes out of the preapproval process. If taxes are lower, then you will be able to afford more house. Homes in a town with lower taxes will usually be priced a little higher to compensate. And then, again IF you are comparing towns that are comparable.
Don't forget to factor in something really mundane...like garbage pick-up. That can run, in my experience, a minimum of $400 per year to $600 per year if it's not included in your property taxes.
Agreed, I have no idea about Mountainside but the services in WO (Garbage pickup and snow plowing etc) are first rate, you pay a premium for the services. The way I see it is that property value in West Orange would be lower than Mountainside due to the high taxes in WO. The payments are not cheaper and theoretically you are right in the long run the higher taxes will cost more. Though if taxes in all towns went up in this decade at the same rate as it did last decade we would have huge problems.
Agreed, I have no idea about Mountainside but the services in WO (Garbage pickup and snow plowing etc) are first rate, you pay a premium for the services. The way I see it is that property value in West Orange would be lower than Mountainside due to the high taxes in WO. The payments are not cheaper and theoretically you are right in the long run the higher taxes will cost more. Though if taxes in all towns went up in this decade at the same rate as it did last decade we would have huge problems.
Spending per capita is about the same in the two towns, so quality of services should be similar in both towns. WO has similar spending per capita (3300) to "the typical" upscale town (Summit, Montclair, South Orange). Some towns spend more per capita (Livingston ~5000). I suspect that the tax rate is high because there are more people and fewer million dollar houses.
The mid term (next decade) outlook for taxes isn't very good -- the state recently allowed towns to delay contributions to the pension fund. Even if they change the way the pension system works, that will only affect new enrollments into the plan, so the costs of the pension system for the next 10 years or so are already locked in (unless someone declares bankruptcy)
Not sure if this thread is correct, but you have not included home value rising or falling as part of calculation.
I live in Mountainside for 14yrs & worked in WO for many (so did dh).
Some of the WO schools are not rated that well. In this part of NJ (not true for other places I know) home values will rise & fall with the quality of the schools. What the home will be worth in 5, 10, 15 years will be directly related to what people will pay for education as opposed to private schools. Also neighboring towns can have a "spill over" effect in crime, etc. I do not think WO to Mountainside is even close. .
Not sure if this thread is correct, but you have not included home value rising or falling as part of calculation.
I live in Mountainside for 14yrs & worked in WO for many (so did dh).
Some of the WO schools are not rated that well. In this part of NJ (not true for other places I know) home values will rise & fall with the quality of the schools. What the home will be worth in 5, 10, 15 years will be directly related to what people will pay for education as opposed to private schools. Also neighboring towns can have a "spill over" effect in crime, etc. I do not think WO to Mountainside is even close. .
I do include it in my analysis -- under the heading "property tax as confiscation of home equity".
I don't get into the game of predicting whether or not a region will transform into a more desirable or less desirable area. This is notoriously difficult to predict, and I'm not taking a position on it. It is not even clear to me that good test scores in the schools lead or lag the area becoming more desirable (for example, Jersey City and Hoboken have gotten expensive, but the test scores at most of the schools have yet to catch up)
Regardless of this, it is the case that high property taxes dig into your appreciation, especially if those property taxes grow too quickly.
The reason I picked those two towns is because one has very low property taxes and the other very high.
Does anyone not already take taxes in to consideration when determining how much house they can afford? I guess I don't really understand the point of this.
Does anyone not already take taxes in to consideration when determining how much house they can afford? I guess I don't really understand the point of this.
Most people figure out "how much they can afford", and then designate that as their budget. That's fine if you're only shopping in one town. If you're looking at more than one town, it's a pretty serious mistake.
Second, as I cover in detail, those property taxes ultimately come out of your home equity. You not only lose buying power up front with higher property taxes, you also lose appreciation, which makes the higher tax place terrible for your long term financial health. With the lower taxed place, you could downsize and move to somewhere cheaper, and end up with a nest egg as a result of the extra appreciation that you got because you didn't choose the higher taxed place. Again, the numbers -- around half a million or so difference -- are enough to have substantial effect on your retirement.
I'm surprised by how few people have bothered to read or think about this stuff -- it's really important if you're buying a home.
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