fundamentals of real estate lecture 26 spring, 2002 copyright © joseph a. petry

Fundamentals of Real Estate

Lecture 26

Spring, 2002

Copyright © Joseph A. Petry

www.cba.uiuc.edu/jpetry/Fin_264_sp02

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Mid-term Exam #3 on Wednesday, April 24th. – MC, 30-40 questions, similar to homework, class examples.– Exam will cover Ch. 13-17, 19. – We will go over Chapter 19 today (Monday). – This will be the last of the new material.

Pat Fitzgerald, Monday, April 29th, 7:00pm, 66 Library.Project Due Wednesday, May 1st. Final, Wed., May 8th, 1:30-4:30, 134 Buell Hall.

– The final will be comprehensive

Final Conflict, Thurs, May 9th, 1:30-4:30, 119 DKH.A Final Exam Review Sheet will be posted by end of this week on web-page.

Housekeeping

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Lender’s Mortgage Loan DecisionsA. 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

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Lender’s Mortgage Loan DecisionsA. 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).


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Lender’s Mortgage Loan DecisionsB. Affordability Ratios

1. Conventional LoansPITI / Gross Income <= 28%

(PITI + Other debt obligations) / Gross Income <= 36%

2. FHA LoansPITI / Gross Income <= 29%

(PITI + Other debt obligations) / Gross Income <= 41%

3. VA LoansNo front-end ratio

Same back-end ratio as FHA


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Lender’s Mortgage Loan DecisionsC. 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.


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Nature of the Tax on Real PropertyThe 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

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A Brief History of the Property Tax in the USThe 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.


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Mechanics of the Property TaxA. 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:

RT = (EB – IO) / (VT – VX)

Where RT = the tax rate; EB = the community’s budgeted expenditures; IO = the total income from other sources; VT= the total assessed value of all properties in the community; and VX=the total value of all property exemptions in the community.


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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


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C. Homestead and other exemptionsSome 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


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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.


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Example of Property Tax Rate ConstructionTaxing Authority Percentage Rate Millage Rate

County 0.008760 8.760Water Management District 0.000050 0.050Schools - State Authority 0.006434 6.434Schools - Local Board 0.004050 4.050City 0.003346 3.346Total Tax 0.022640 22.640

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Property Tax CalculationItem Example Amount

Market Value 139,500$ x Percentage of MV 90%= Assessed Value 125,550$

less Exemptions (homestead) 25,000= Taxable Value 100,550$ x Millage rate / 1,000 0.02264= Tax due 2,276.45$

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Example:Assume local millage rates of:

County 9.250

Water Management District 0.045

Schools 8.750

City 4.030

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?


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E. The Effective Tax Rate

actual tax paid / the property’s market valueWhich from the previous example

= 2276.45/139,500 = 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


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Tax Burden AnalysisComparable A B C D Subject

Tax Liability, 1999 $1,000 $1,150 $975 $1,050 $1,200Recent Sale Price, or value 92,500 112,000 98000 105000 100000Effective Tax Rate 1.03% 1.00%Mean effective tax rate (of comparables) =

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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).


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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


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Criteria for Evaluating the Property TaxProperty taxes may be evaluated on the basis of:A. EfficiencyB. Equity

A. Efficiency of the Property TaxEfficiency 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


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Criteria for Evaluating the Property TaxA. 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


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B. Fairness, or Equity of the Property TaxEquity refers to the equal (fair) taxation of property owners who are

in the comparable ownership positions

1. Horizontal or vertical equityHorizontal 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.


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B. Fairness, or Equity of the Property Tax

3. Property taxes are not related to one’s ability to payThis criticism suggests that high-income households are better

able to meet property tax obligations than lower-income households

4. Property taxes very among geographic areasInconsistencies can be found, even within single tax

jurisdictions, with respect to the implementation of the property tax.


fundamentals of real estate lecture 26 spring, 2002 copyright © joseph a. petry

Documents

housekeeping slide

underwriting standards

adequate income

final exam review sheet

app fee application

residential mortgages

borrowers income

sources of funds