When taking out a home equity loan, several states require that you pay a mortgage recording tax. Don't get caught off-guard by this tax. Here's an example of how it works in New York City.

The lifestyle and excitement of New York City have inspired many musicians, from Frank Sinatra to Grandmaster Flash. While Big Apple locals might relate to lyrics like "the city that never sleeps," and "big city of dreams," there's another side that has some homeowners singing the mortgage tax blues.

Taking a bite out of homeowners

Homeowners in the state of New York are already familiar with the state's mortgage recording tax. The structure of the tax is somewhat complex; rates vary depending in which city or taxing district the mortgaged home is located. Single-family homes within New York City can be assessed as much as $2,145 of upfront costs per $100,000 of mortgage. The lender technically pays some of these fees, but you can bet that homeowners are paying the price in the form of higher rates.

Things can get confusing for New York City homeowners who wish to open a home equity line of credit (HELOC). While the recording tax is based on the loan amount, some homeowners aren't sure what that means: Is it the amount of money funded at closing, or the total amount of the credit line? Unfortunately, the recording tax is based on the total amount of the credit line, whether all of it is funded or not.

The mortgage recording tax rates for New York City residents are calculated as follows:

• For mortgages and HELOCs in amounts less than $500,000, the tax is equal to 2.05 percent of the principal. Where the mortgaged property is a one- or two-family house, the tax is reduced by 0.3 percent of the first $10,000 of principal (or $30).
• For mortgages and HELOCs in amounts greater than $500,000, the tax is equal to 2.175 percent of the principal. If the mortgaged property is a one- or two-family house, the tax is reduced by 0.3 percent of the first $10,000 of principal (or $30).

Case in point

If a homeowner opens a HELOC in the amount of $200,000, but only borrows $75,000, the tax is still based on the $200,000. Applying the 2.05 percent to $200,000 equates to a tax amount of $4,100. Subtracting the $30 reduction, the total tax due would be $4,070.

The lender is required to pay a small portion of the tax, usually 0.25 of the principal. Some will absorb the entire recording tax, as long as the homeowner keeps the HELOC open for a certain period of time. Homeowners should ask their lender about the mortgage tax well in advance of closing. Current states already charging it include Alabama, Florida, Georgia, Hawaii, Kansas, Maryland, Minnesota, New York, Oklahoma, Tennessee, and Virginia. With a little planning, New York homeowners can live in the "big city of dreams" without having nightmares over the cost of their HELOCs.