How Does Someone Become House Poor?
Buying a house can be an exciting prospect, but detrimental to your finances if something goes wrong or is overlooked. Home buyers can find themselves house poor if any of the following happens:
They Underestimate Their Homeownership Costs
First-time home buyers may simply not plan beyond the money needed to buy a house – the down payment and closing costs are just the start of the lifelong expenses of owning a home.
Meanwhile, the costs of owning a home can be significant, and you should include them when you’re creating your house buying budget. More than the monthly mortgage payment goes into buying a home.
Consider these costs of owning a home before moving forward with a home purchase.
Homeownership Costs
If you’re moving from an apartment or condo to a single-family house, you may be shocked when you get your first utility bill, which may be higher than you’ve been paying for a smaller home. You should also factor in costs like increased transportation expenses or services like landscaping or snow removal. There may also be trash pickup services to pay for, and you may need to purchase garbage cans as well.
If you have a lot of yard space, you’ll need items like shovels, rakes, wheelbarrows and household tools for basic lawn maintenance and repairs. It adds up quickly.
Property Taxes
Although these are usually included in your monthly mortgage payment, along with homeowners insurance in an escrow account, one of the important things to realize is that your mortgage lender is preapproving you based on an estimated initial property tax.
This is one of the biggest items that changes after you buy a home. Your home’s previous owner disclosed what they’d been paying based on the home’s assessed value. If you paid significantly more than their assessed value, your taxes rise accordingly because your purchase price becomes the new assessed value of the home.
Visit the website of the property taxing authority where your new home is located to find out exactly what your tax bill will be after purchase, whether there are any property tax rate hikes on the horizon and how often property values are assessed.
Homeowners Association (HOA) Fees
If the home you’re considering is located within a homeowners association (HOA), you’ll have to pay HOA fees in addition to property taxes and homeowners insurance. Unlike these other expenses, though, HOA fees aren’t included in an escrow account and aren’t part of your monthly mortgage payment.
Because of this, they can be easy to forget until they become due. They also tend to rise over time. There can also be special assessments to meet major maintenance costs. Check the homeowners association meeting minutes for at least the past year to see if there are any plans for major maintenance on the horizon.
If you fail to stay current on your HOA fees, you may face penalties and interest on those fees. If you don’t pay, eventually you’ll have a lien placed on your property, which will make it difficult to refinance or sell your home.
Maintenance Expenses
Something is eventually going to break in your home. While it’s impossible to say when, you can make some educated guesses based on how old the home is and when major systems, the roof and any included appliances were last replaced. Maintenance costs are often between 1% – 3% of the purchase price of your home each year. Whether you can expect to be at the low or high end of that range typically depends on the age of your home.
If you’d prefer to have a stable home maintenance cost that handles unforeseen contingencies, you may want to consider a home warranty.
They Experience A Change In Circ*mstances
If you’re approved for a mortgage based on your monthly income, you could struggle to afford your monthly mortgage payments if you lose your job. Unless you can find another job quickly, your finances could take a huge hit.
Your circ*mstances can change outside of your employment as well. The costs of living in your area could go up suddenly, or the interest rates on your credit cards could rise.
For these reasons, it’s important you try to leave room in your budget for emergencies, raising costs and potential loss of income.
How To Avoid Becoming House Poor: 5 Helpful Tips
There are a few preventative measures you can take to avoid becoming house poor.
1. Create A Home Buying Budget
If you’re thinking about buying a home, first create your home buying budget, which should also account for after you own the home. Make sure you include line items for things you love and do not want to give up.
While you may have to eliminate any overspending you might normally do, don’t give up everything you love when you buy a house. You might come to resent your home if you aren’t living a life you enjoy.
2. Buy A Less Expensive Home
Consider buying a starter home or condo if you’re not yet ready to give up your lifestyle in favor of owning your forever home. Starter homes and condos tend to be smaller in size and closer to urban centers, which may reduce transportation costs.
Another option is to opt for a longer-term mortgage, like a 30-year versus a 15-year fixed-rate mortgage. Your monthly payments will be far lower, although you’ll pay more in interest. Once you’re comfortable with your monthly mortgage payment or are able to remove private mortgage insurance (PMI), you can refinance into a shorter term.
Finally, if you’re not planning to stay in the home more than 5 years, consider an adjustable-rate mortgage (ARM) with a low introductory interest rate. Plan to sell or refinance before the introductory period ends.
3. Use The 28% Rule
The 28% rule is a general guideline for how much you should spend on a house. The rule says you should try to spend no more than 28% of your monthly gross income on housing expenses. To determine what your monthly homeownership budget should be under this rule, simply multiply your monthly income by 28%.
The idea is to give you room in your budget so that you’re not pushing the limits. It’s worth noting that sticking to a hard 28% limit may be tougher given the expense of some housing markets where home prices are extremely high.
4. Review Your Debt-To-Income Ratio (DTI)
Debt-to-income ratio (DTI) compares the amount spent on monthly installment and revolving debt payments to your gross (pretax) monthly income. DTI is part of what lenders use to determine the amount of your mortgage approval. The DTI you’ll need to qualify for a mortgage will depend on the specific loan type you apply for, your lender and other aspects of your financial profile. That said, it’s generally recommended that you keep your DTI around 43% or lower.
There are two different types of DTI. Back-end DTI is what’s most often used in lending approvals. This compares all of your minimum monthly debt payments, including your mortgage, to your gross monthly income. Experts recommend that your back-end DTI be no higher than 36%.
Meanwhile, front-end DTI (or housing expense ratio) compares just your monthly mortgage payment to your income. This is also sometimes used in lending. Front-end DTI is the basis for the 28% rule discussed above, which effectively recommends keeping your front-end DTI at or under 28%.
DTI can be a useful metric in determining just how much house you can afford when making an offer. It’s just important that you don’t go to the very top end of your budget. Try to think about your expenses holistically.
5. Create An Emergency Fund
Having an emergency fund can create peace of mind if you ever experience financial hardship or need to make a large and important purchase. A good emergency fund should have about 3 – 6 months’ worth of savings that could account for living expenses in extreme circ*mstances.
What To Do If You’re Already House Poor
If you're feeling house poor right now, the best way to get yourself out of that situation is to lower your expenses or raise your income. You may be able to do that through the following means.
Refinance Your Home
Refinancing your mortgage is one way to potentially lower your monthly mortgage payment. Depending on your current credit score and DTI, as well as current market rates, you may be able to refinance to a mortgage with a lower interest rate. This could help you pay less each month and save some money for other expenses.
Besides lowering your rate, you could refinance into a longer term. If you were in a 15-year mortgage, and lost your job 5 years into your repayment, you could refinance your remaining 10 years of repayment into a 30-year fixed loan to significantly lower your monthly mortgage payment. It could allow you more room in your budget. You could also choose to put more toward your payment to pay off the loan sooner if there came a time when you had more money available.
Sell Your Home
If you feel you can no longer comfortably afford the home you have, another option is to sell your home and downsize. On one hand, you might be leaving your dream home. On the other hand, you’ll have the financial peace of knowing you’re now in a home you can afford. It’s an option to consider if you’re reassessing your finances.
Limit All Discretionary Spending
If you’ve experienced a recent financial shock, like a job loss or an unexpected big bill, you may be able to help yourself by limiting or eliminating discretionary spending for a while. Budget only for the things you must have.
This may not be fun, but it might be a necessary measure for you to take until a long-term solution is in place and the urgency that led to a tight budget has passed.
Use Your Savings
If you’re really struggling, tap into any emergency savings you have. While this isn’t something that should be taken lightly, it could work as a short-term solution until you’re able to get a better hold of your finances.
This is generally a better solution than missing payments on a home or car, particularly if you’re trying to preserve credit in the event that the long-term solution is to refinance your current mortgage or downsize into a different home.
Raise Your Income
While it’s definitely true that it’s easier said than done, there are steps you can take to raise your income. When put together with sensible spending limitations, this could give you more security in being able to afford your home.
Ask For A Raise
If you can make a good case, it doesn’t hurt to ask your employer for a raise. Be prepared to back your case for a raise with strong evidence of your performance and how it’s driven success across your team, the department and even the company. The more you can make yourself seem like an irreplaceable contributor, the better.
Get A Second Job
If a raise isn’t in the cards, another viable way to boost your income might be a second job or side hustle. It could be something like personal shopping or food delivery. You might also be able to pick up freelance work you can do from home on sites like Fiverr or Upwork. These opportunities make it easier to pick up extra money while working on a flexible schedule that still accommodates your current career goals.
