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Fundamentals of Real Estate Lecture 26 Spring, 2002 Copyright © Joseph A. Petry www.cba.uiuc.edu/jpetry/Fin_264_sp02.

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Presentation on theme: "Fundamentals of Real Estate Lecture 26 Spring, 2002 Copyright © Joseph A. Petry www.cba.uiuc.edu/jpetry/Fin_264_sp02."— Presentation transcript:

1 Fundamentals of Real Estate Lecture 26 Spring, 2002 Copyright © Joseph A. Petry

2 2 Mid-term Exam #3 on Wednesday, April 24 th. – MC, questions, similar to homework, class examples. – Exam will cover Ch , 19. – We will go over Chapter 19 today (Monday). – This will be the last of the new material. Pat Fitzgerald, Monday, April 29 th, 7:00pm, 66 Library. Project Due Wednesday, May 1 st. Final, Wed., May 8 th, 1:30-4:30, 134 Buell Hall. – The final will be comprehensive Final Conflict, Thurs, May 9 th, 1:30-4:30, 119 DKH. A Final Exam Review Sheet will be posted by end of this week on web-page. Housekeeping

3 3 Lender’s Mortgage Loan Decisions A. Underwriting Standards When making a loan, lenders face two types of risks: 1. Borrower will be unwilling or unable to meet debt payments 2. Value of security for loan will be inadequate to pay off the balance in event of default or foreclosure Loan application process begins with application form and app fee Application form asks applicant for information regarding the property, borrower’s income and net worth, judgments and credit references. Chapter 16: Sources of Funds for Residential Mortgages

4 4 Lender’s Mortgage Loan Decisions A. Underwriting Standards To judge acceptability, the underwriter looks at: 1. Credit history 2. Employment outlook 3. Adequate income 4. Adequate security The mortgage underwriting industry’s application evaluation criteria is commonly referred to as the three C’s (collateral, credit, and capacity). Chapter 16: Sources of Funds for Residential Mortgages

5 5 Lender’s Mortgage Loan Decisions B. Affordability Ratios 1. Conventional Loans PITI / Gross Income <= 28% (PITI + Other debt obligations) / Gross Income <= 36% 2. FHA Loans PITI / Gross Income <= 29% (PITI + Other debt obligations) / Gross Income <= 41% 3. VA Loans No front-end ratio Same back-end ratio as FHA Chapter 16: Sources of Funds for Residential Mortgages

6 6 Lender’s Mortgage Loan Decisions C.Effects of Federal Programs and Regulations The Home Mortgage Disclosure Act (HMDA) of 1975 provides the disclosure of loan applications and approvals. This act serves to discourage lenders from “redlining” certain neighborhoods. The Community Reinvestment Act (CRA) of 1977 encourages lenders to actively lend in their community and evaluate their lending practices. Chapter 16: Sources of Funds for Residential Mortgages

7 7 Nature of the Tax on Real Property The tax on real estate property represents the largest single source of revenue for most local governments Property taxes are levied on real estate based on their assessed values. These are termed ad valorem taxes (i.e. according to value) Unlike many countries, the US Constitution prohibits a federal property tax. Chapter 19: Real Property Taxation

8 8 A Brief History of the Property Tax in the US The US property tax system was derived from the English system. In the British colonies of North America the following five types of taxes were used: – The poll tax (flat tax on all adult males) – The property tax (typically not related to value) – The faculty tax (tax on a person’s trade) – The import tax (on goods exported and imported) – The excise tax (on some consumption goods, e.g. liquor) Property ownership was eventually viewed as an indication of one’s ability to pay. Thus taxation on all types of property (I.e. tangible and intangible, personal and real) Today most jurisdictions focus on real property tax, but in some communities other types of property may still be taxed as well. Chapter 19: Real Property Taxation

9 9 Mechanics of the Property Tax A. Determining a Jurisdictions Budget & Tax Rate A jurisdictions tax rate is established as a percentage of its budgeted expenditures to its tax base. The tax base is the aggregate taxable value of all properties in a community, or jurisdiction, minus the total value of all property tax exemptions. The basic value for determining the tax rate is: R T = (E B – I O ) / (V T – V X ) Where R T = the tax rate; E B = the community’s budgeted expenditures; I O = the total income from other sources; V T = the total assessed value of all properties in the community; and V X =the total value of all property exemptions in the community. Chapter 19: Real Property Taxation

10 10 Property tax rates are generally stated in mills, or as a millage rate (tax dollars / $1,000 of value). Twenty mills is equivalent to a tax rate of 2.0%. B.Tax Exempt Properties Typical tax exempt properties include, but are not limited to: Government owned properties Schools and universities Hospitals Places of worship Chapter 19: Real Property Taxation

11 11 C.Homestead and other exemptions Some states allow homeowners to reduce their assessed value by a specified amount, before calculating their tax bill. The largest of these is the homestead exemption which is given to property owners that occupy their home as the family’s principal residence. The homestead exemption is a subsidy to encourage home ownership Properties that may receive partial exemptions include: Homesteads Agricultural properties Properties owned by seniors, veterans and disabled individuals Chapter 19: Real Property Taxation

12 12 D.Calculating an individual’s Tax Liability The tax assessor (or county property appraiser) appraises all taxable properties in a jurisdiction for property tax assessment. The assessed value is always related to a property’s market value (e.g. 90% of market value). Many states require the assessed value to be 100 percent of market value. The taxing authorities establish a total tax rate for an area. Chapter 19: Real Property Taxation

13 13 D.Calculating an individual’s Tax Liability Chapter 19: Real Property Taxation

14 14 D.Calculating an individual’s Tax Liability Chapter 19: Real Property Taxation

15 15 Example: Assume local millage rates of: County9.250 Water Management District0.045 Schools8.750 City4.030 The market value of the home you would like to purchase is 176,500. Assessed valuation is based on 85%. There are two exemptions in your area: homeowners (30,000) and senior citizens (10,000). Your real estate taxes due each year are: What is the value of the homeowners exemption? The senior citizen exemption? Chapter 19: Real Property Taxation

16 16 E.The Effective Tax Rate actual tax paid / the property’s market value Which from the previous example = /139,500 = 1.63% And in the example you worked = Tax burden analysis can be used to test consistency of tax rates on a given property (see next slide) Taxpayers wishing to contest their tax assessment may: Appeal to the property appraiser Continue to appeal to appraisers board (board of equalization) May ultimately appeal the assessment in court system Chapter 19: Real Property Taxation

17 17 Chapter 19: Real Property Taxation

18 18 F.Special Assessments A tax charged to a property to help pay for a local improvement that directly benefits the parcel is termed a special assessment. Special assessments are: Not generally assessed according to the value of the property, but rather are assessed relative to property size, linear footage, or curb frontage footage. Generally a one-time charge Special taxing districts may levy special assessments on properties in a particular location of the community (e.g. downtown improvement district). Chapter 19: Real Property Taxation

19 19 G.Nonpayment of taxes – If property taxes are not paid, the property may be foreclosed and sold at a public auction. Property tax liens have first claim to the proceeds from a public sale. – Equity of Redemption is owner’s right to pay unpaid taxes plus interest and penalties before public sale and to reclaim the title to the property – Statutory Redemption is the original owner’s right to pay all accrued taxes, interest and any penalties after the public sale and to reclaim clear title to the property – In some states, tax certificates are used to pay unpaid taxes. – Tax certificates are: Purchased at a public auction Require the property owner to pay the holder of the tax certificate the taxes, interest and penalties owed on the property by a specific date, and If left unpaid may be used to force a public sale of the property Chapter 19: Real Property Taxation

20 20 Criteria for Evaluating the Property Tax Property taxes may be evaluated on the basis of: A. Efficiency B. Equity A. Efficiency of the Property Tax Efficiency pertains to the ability to raise revenues at a relatively low cost to society 1. Potential advantages of the Property Tax Capable of raising large amounts of revenues b/c of large tax base It cannot be easily hidden to avoid taxation The value of the property can be established at a low cost Discourages land hoarding Base of revenues tends to keep up with inflation Chapter 19: Real Property Taxation

21 21 Criteria for Evaluating the Property Tax A. Efficiency of the Property Tax 2.Potential disadvantages of the Property Tax Increased property taxes may lower values through tax capitalization Property taxation of improvements may inhibit new construction Property taxation may inhibit maintenance and rehabilitation Property taxation may induce premature development of land Chapter 19: Real Property Taxation

22 22 B.Fairness, or Equity of the Property Tax Equity refers to the equal (fair) taxation of property owners who are in the comparable ownership positions 1. Horizontal or vertical equity Horizontal equity refers to properties of the same market values being assessed at the same percentage of market value Vertical equity refers to properties of different market values being assessed at the same percentage of market value 2. Regressive nature of property tax Taxes are regressive if lower-income households pay higher taxes than higher-income households relative to incomes. Property taxes tend to be regressive. Chapter 19: Real Property Taxation

23 23 B.Fairness, or Equity of the Property Tax 3.Property taxes are not related to one’s ability to pay This criticism suggests that high-income households are better able to meet property tax obligations than lower-income households 4.Property taxes very among geographic areas Inconsistencies can be found, even within single tax jurisdictions, with respect to the implementation of the property tax. Chapter 19: Real Property Taxation


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