What Does It Mean To Be House Poor And How Can You Avoid It?
Kevin Graham10-minute read
May 09, 2022
Buying a home can be an exciting prospect. Maybe you’ve been preapproved so you know the top end of the budget. You also have a checklist of everything you want in your house and you’ve found one on the upper end of your affordability range that has it all.
Before making an offer on that home that may stretch your ability to afford the payment, you should take a second to reassess. In this article, we’ll talk about what it means to be house poor and the problems associated with it. After discussing how people come to be house poor, we’ll go over how to avoid it and what to do if you already find yourself in this situation.
House Poor Meaning
When someone is house poor, it means that an individual is spending a large portion of their total monthly income on homeownership expenses such as monthly mortgage payments, property taxes, maintenance, utilities and insurance. This excess spending is making it difficult or impossible for them to achieve their other financial or personal goals. You may be making your house payment and paying for life’s necessities, but there’s not much left over at the end of the month.
The most common cause of being house poor is not realizing the true cost of homeownership. The down payment is just the start. Unlike when you’re renting, you’re responsible for getting things fixed when they break.
You can be house poor regardless of your median household income level if you’re spending too much on your home. It doesn’t matter whether you’re an average Joe or a multimillionaire. If the percentage of income being spent on your home is too high, it can prevent you from achieving your long-term financial objectives.
Why Is It Bad To Be House Poor?
Your home serves as your sanctuary and is a place where you can raise a family, have friends over and make memories that last a lifetime. There’s also no denying that a home can be a major financial asset as part of your wealth and investment portfolio. With that investment, some monthly cost is worth the long-term benefits. However, the problem comes from overdoing it.
Your house and the expenses that go with it still represent only one piece of your monthly budget. Becoming house poor can affect your ability to save for retirement, pay off debt or afford other purchases.
Experts recommend saving 3 – 6 months’ worth of living expenses for an emergency fund. That’s before considering retirement savings. Finally, it’s nice to have some discretionary spending for nights out and vacations.
If you find yourself in a situation where you’re house poor, that might leave you living paycheck to paycheck and feeling one setback away from financial disaster. Any change in your circumstances has the potential to lead to major issues. These problems can even put a strain on your relationships and your mental well-being.
How Do People Become House Poor?
Now that we know what house poor is, how do people get that way in the first place? There are two big causes: a lack of awareness of the true costs of homeownership and sudden changes in circumstances.
Poor Understanding Of The Costs Of Homeownership
More than the mortgage payment goes into buying a home. It's a good idea to do research on future household expenses before moving forward with a home purchase so that you're not surprised in a big way. Many expenses may cost more than you think they will, so the more you know going in, the better you can be prepared. Here’s a list of expenses beyond the mortgage to think about:
- Property taxes. Although these are usually included in your monthly mortgage payment along with homeowners insurance if you have 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 fluctuates after you buy a home. If your property value rose a lot from what the previous owner paid for the house, your taxes are likely to do the same. Make sure you understand how often values are reassessed and how rates are set. You can also get an idea of past taxes by looking at city real estate assessors property records.
- Homeowners association (HOA) dues. While these are also included in your monthly mortgage payment that a lender uses to qualify you, they’re not included in an escrow account and aren’t part of the payment itself. Because of this, they can be easy to forget until they become due. They also tend to rise over time. You can prepare yourself by speaking with the HOA about getting what the current dues are and obtain a back history if possible.
- Maintenance costs. 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 often depends on the age of your home.
- Down payment and closing costs. Although the down payment and other closing costs are paid upfront and not something to think about from a monthly expense perspective, this represents a significant outlay of savings. With that in mind, it’s important to consider how much you have to put down on the home in light of your other financial goals and aspirations for the near future when buying a home.
Change In Circumstances
The loss of a job is a tough pill to swallow under normal circumstances. Given the current national struggle with COVID-19, the job market can be a challenge to predict. Moreover, this situation may make it even more difficult than usual to find a job to replace the lost income.
Even if you’re working, there are other situations that can play a factor, like a major unexpected medical expense. These things can ruin your best-laid plans. Whatever the case, you’re going to be in a better position for the future if you’re not stretching your budget to the max in order to pay housing expenses.
What Percentage Of My Income Should Be Allocated Toward Housing?
While it would be foolish to say that there’s a one-size-fits-all approach to the right amount for a housing budget, there are a variety of methods you can use to help you determine how much you should realistically spend on a home. We’ll cover a couple of them here.
The 28% Rule Of Thumb
The 28% rule is a general guideline that 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 for yourself may be tougher given the expense of some housing markets where home prices are extremely high. For example, those in the Big Apple or Silicon Valley may find it impossible.
One recent factor that may help mitigate this is that the forced nature of working from home in the time of COVID-19 has caused companies to reevaluate how often and if their employees need to be in the office. Because of this, you may find that you can live further out in the suburbs or even rural areas away from big city centers, which could help with affordability.
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 what lenders use to determine the amount of your mortgage approval.
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 gross monthly income. Meanwhile, front-end DTI (or housing expense ratio) compares just your monthly mortgage payment to your income. This is also sometimes used in lending.
Experts recommend that your front-end DTI be no higher than 36%. For some loans, you may need this number to be even lower depending on your situation. The housing expense ratio can be a useful number to help make sure that you’re not spending a ton of money on the house at the expense of other efforts.
Once all of your other data is added in, you can be approved for a loan with a DTI as high as 60% if it’s a VA loan. For the best chance of approval on many other products though, it’s generally recommended that you keep your DTI at around 43% or lower.
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.
What Should I Do If I’m 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. In the next few sections, we’ll look at the expense portion of the equation before touching on income.
Refinance Your Home
If you haven’t refinanced your home in a while, there are a few things that could be working in your favor right now if you’re looking to get a lower monthly payment. To begin with, mortgage rates are near historical lows. If you can get a lower interest rate, that’s going to help you secure a lower payment, assuming the same or a longer term.
Second, home values have generally been going up across most of the country, so you may have more equity in your home than you think. If you’ve done any renovations, this also has the impact of increasing the value of your home. However you get there, having more equity in your home means less risk for lenders. This can translate into a lower rate when you refinance.
Besides lowering your rate, the other option you would have would be to go for a longer term. If you were in a 15-year mortgage, you might go to 20 years. 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, permanently or temporarily. 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 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 definitely isn’t fun, but it may be a necessary measure for you to take until a long-term solution is in place and the urgency that led to an austerity budget has passed.
Use Your Savings
If you’re really struggling, tapping emergency savings in the event of a shock could be a necessary short-term stopgap measure until you can get on better footing in the long term. While this isn’t something that should be taken lightly, emergency funds are kept up for the purpose of temporary crises.
This is always going to be 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 to say than it is to do, 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. It may seem odd to ask for a raise, particularly in light of the situation we find ourselves in economically. However, the worst they can do is say no. If you can make a good case, it doesn’t hurt to ask.
You may also have a pretty good idea at this point of how your employer is handling the turmoil being caused by COVID-19. If the company is struggling, it might be a tougher sell. On the other hand, there are definitely some industries that have actually benefited from the changes that have resulted from this situation. It all depends where you work.
In any case, be prepared to back your case for a raise with strong evidence of your performance and how it’s driven success across your team, 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. Although this may not sound appealing, COVID-19 has only accelerated the trend toward the gig economy that started a few years ago.
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 even easier to pick up extra money while working on a flexible schedule that accommodates your current career goals.
The Bottom Line: Being House Poor Can Make You Resent The Home You Love
While your home is both your place in the world and a significant asset in your financial portfolio, you shouldn’t spend so much that you’re house poor, having to put aside every other financial and personal goal in order to make your house payment. If you do this, you may have a hard time enjoying life in your home because you can’t save for retirement or family vacations, for example.
One of the big reasons people end up house poor is not understanding the true costs of homeownership. This includes things like maintenance, taxes and HOA dues. Another might be a sudden change in income or an unexpected bill.
To avoid being house poor, you can keep a close eye on your DTI and try not to put more than 28% of your income toward housing expenses on a monthly basis. If you find yourself in a situation where you’re spending more on a real estate property than you want, you can try to refinance into a lower payment, sell your home and downsize, cut back where you can and use your savings temporarily.
Although it’s not always feasible, you could also work to up your income by asking for a raise or getting a second job to supplement your earnings.
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A Guide To The Housing Expense Ratio
Home Buying - 3-minute read
Andrew Dehan - May 23, 2022
Wondering how mortgage lenders calculate the housing expense ratio? Learn how to find your results by comparing your housing expenses to your pre-tax income.