Lender Paid My Property Taxes--How Much Will It Cost Me to Undo This?

Deep in the language of your mortgage contract, you may find a clause allowing your lender to pay your property taxes when you've failed to do so, and then claim reimbursement.

Question

I was so busy with my job this year that my pile of bills turned into a total mess, and I kept forgetting to pay my property taxes. I was just about to take care of this when I opened a letter from my lender, saying it paid the taxes for me and I will now owe the lender! It also looks like I might now owe both tax penalties and extra interest to my lender. My income is enough to keep me out of foreclosure, but extra costs like this hurt. Help! Isn't there some way I can get out of this?

Answer

Unfortunately, you’re on the hook to pay the lender back for the entire amount of the taxes and penalties it paid on your behalf, plus interest. You’ll have to make this payment if you don’t want to risk a foreclosure.

Why the Lender Paid Your Property Taxes

When you don’t pay your property taxes, the overdue amount becomes a lien on your home. In most cases, property tax liens have priority over other liens, such as a mortgage lien. (Learn more about lien priority.)

Because this type of lien has priority over a mortgage, the lender faces the prospect of its mortgage being wiped out if your home is sold through a tax sale. To make sure this doesn’t happen, the lender will usually pay delinquent property taxes out of its own pocket. (Learn more in Nolo’s article What Happens If You Don't Pay Property Taxes on Your Home?)

After the lender advances money to pay the delinquent taxes (along with any penalties owed), it will usually turn around and demand repayment for these amounts, plus interest, from you, the homeowner.

What Happens If You Don’t Pay the Lender Back

If you don’t reimburse the lender, this constitutes a default under the terms of the mortgage.

What’s a mortgage default? A “default” occurs when you fail to live up to the terms of the mortgage contract. The most common type of mortgage default is falling behind in the monthly payments, but other types of default include (among others):

  • not paying the property taxes or
  • not reimbursing the lender for amounts it paid for property taxes on your behalf.

After you default on the mortgage, the lender can then foreclose on your home. So, you’ll have to pay the lender back if you want to avoid a possible foreclosure. (To learn about how foreclosure works in your state, visit Nolos'Foreclosure Center.)

Your Lender Might Set Up an Escrow Account

In addition to demanding repayment of the amount it paid for the taxes, penalties, plus interest, your lender will probably set up an escrow account for the loan.

How escrow accounts work. With an escrow account, you pay the lender a certain amount each month, which will be used to cover property taxes and homeowners' insurance. The lender holds the money in a special account, and then pays for those items on your behalf as the bills come due. This ensures that your taxes and insurance premiums are paid on time and in full.

How much you’ll have to pay. Each month, you’ll have to pay approximately one-twelfth of the estimated annual cost of property taxes and insurance along with your usual monthly payment of principal and interest.

Pros and cons to having an escrow account. The downside to having an escrow account is that you’ll have to make a bigger payment to the lender each month. On the up side, having an escrow account saves you from having to come up with the large amount of money when the tax and insurance bills are due.

What gives the lender the right to set up an escrow account? Most mortgages have a clause that gives the lender the ability to establish an escrow account basically at any time it chooses.

To find out if and when the lender can set up an escrow account for your loan, read your mortgage contract and any other relevant documentation you signed (such as an escrow waiver).

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