When you take out a mortgage, your lender is worried about more than making sure it gets repaid. If you don't pay your property taxes, your lender could lose out if the government forecloses on your home. Thus, lenders typically require you to pay a tax hold-back, which is a payment you make into an escrow account for the amount of the anticipated property taxes so the lender can rest assured that the property taxes will be paid.
How It Works
A tax hold-back, unlike tax withholding from your salary, is technically at the lender's discretion. However, virtually all lenders will require it to protect themselves against you not paying your property taxes. After you purchase the home, part of your mortgage payment is put into escrow each month to pay for the upcoming property taxes. That way, the bank can make sure you're paying your taxes on time.
The amount of the hold-back varies, depending on the lender. Lenders usually want to hold back more than what was collected the prior year -- typically 10 to 20 percent more -- in property taxes. For example, if the prior year's bill was $1,000, you're on the hook for between $1,100 and $1,200. But, if you're buying the property in the middle of the tax year, some of that cost may be covered by the seller. On the bright side, if too much is held back, you get any excess refunded. For example, if you have $1,200 held back and your property tax bill turns out to be $1,150, you get a $50 refund.
Splitting the Hold-Back
The tax hold-back is usually split between the buyer and the seller, based on how much time during the taxing period, usually the calendar year, that each occupies the house. For example, say the seller lived in the home for the first 30 percent of the time, the buyer owned the home for 70 percent and the total tax hold back was $1,200. The seller would be responsible for $360 and the buyer would cover the remaining $840.
Just because a tax hold-back isn't included on your good-faith estimate of closing costs doesn't mean you're not going to be expected to pay it. According to Mortgage Trust, many times lenders simply "forget" to include it, which means you could end up paying more at closing than you anticipated. When you get a good-faith estimate, ask your lender if it includes any tax hold-backs, and if not, find out how much you might be expected to pay.
Based in the Kansas City area, Mike specializes in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."