July 16, 2018
July 16, 2018
Have you ever heard the term, house poor? It’s an important term to remember when you buy a home. It refers to someone who buys a house that they can barely afford, leaving them with little money left over to pay for anything else.
It’s a tough situation to be in because it means that while you may have the house of your dreams, everything else in life becomes a struggle. Major repairs become a serious burden, and there’s not much money left over for fun, like taking vacations or eating out at your favorite restaurant. At the extreme, being house poor can even lead to foreclosure.
How can you buy a home without leaving yourself house poor? Most of it involves being smart when you first by the home. After that, it’s just a matter of properly managing your finances.
If you have strong credit, and you’re making a large down payment on a home, you might be approved for a loan that results in a monthly house payment that’s above 28% of your monthly income. But just because you qualify for that loan, doesn’t mean that it’s the right loan for your budget.
The 28% limit was established decades ago, and not without reason. By experience, lenders determined that a household can typically afford to comfortably manage a house payment that’s roughly one-quarter of their income. But exceeding that amount substantially could lead to a permanent budget squeeze.
The best strategy is to keep the payment at no more than 28% of your monthly income. A little bit lower is even better. The less that you are paying on your monthly house payment, the more money that you will have available for everything else.
That will include having extra in your budget to save money on a regular basis. When you’re a homeowner, you always need to have at least some cash put aside for unexpected expenses. By keeping your base monthly house payment low enough, you’ll have the savings that you need.
Home buyers often pull out all the stops when it comes to qualifying for a mortgage. That means using every income source available to qualify for the monthly payment. But while that may sound like a noble thing to do, it could lead to problems later on, and contribute to you becoming house poor.
Even if you have over-time, bonuses or a part-time job, it may be best to qualify for your loan without declaring those sources. This is especially true if there’s any doubt as to whether or not they will continue.
The reason is so that you will have a built-in cushion in your budget. For example, if you’re paying for your basic living expenses out of your base pay alone, the extra money that you earn can be used for other purposes.
Also, should any of those extra income sources be lost, you will still be able to afford to comfortably live in the home.
So far we’ve been talking about keeping your new house payment manageable. But even if you accomplish that objective, the benefit can be lost if you have too much non-housing debt.
Non-housing debt is any debt other than your primary house payment. It can be student loans, car payments, credit cards, or even a home equity loan or second mortgage taken after the closing.
The monthly payments on all of these debts compete for space in your budget with your basic monthly house payment. If they become excessive, you could end up becoming house poor equivalent, even if your basic house payment is easily manageable.
It’s easier to get into this dilemma than you might imagine. It can start by qualifying for a mortgage with an already excessive amount of non-housing debt. Once again, a lender might approve you with a higher total debt-to-income (DTI) ratio because of your excellent credit or a large down payment.
It can also happen if you begin going into a large amount of debt after closing on the new home. For example, you may decide to furnish the home using credit cards or furniture loans. Or you might decide to buy a brand-new car, with a large monthly payment.
But if debt is eating up too much of your income, you may find yourself with very little wiggle room after closing, or even shortly after that.
When you purchase a home, it’s important that you become savvy about managing your budget. Too much expense in any given area of your budget could leave you house poor in short order.
Many homebuyers try to buy at or above their means. For example, though you may qualify to purchase a $300,000 home, you instead buy one for $350,000.
Since the higher priced home is about 17% more expensive, it also causes your house payment to be 17% higher than what you were initially approved for.
It may be nice to have a larger or more expensive home, but in the months and years after you move in, it can leave you with far fewer financial options. That’s how the house poor process begins. You stretch to buy a house that’s just beyond a comfortable fit in your budget, and then have little left over afterward. It’s a vicious cycle that can be extremely hard to get out of.
Rest assured that when you purchase a home, you will have unexpected expenses. They could be the result of repair bills, or the cost of necessary home furnishings and appointments, such as window treatments. They can also come from special assessments, that may be charged by either a homeowner’s association or even the tax authorities.
If you have no money left over after closing, and any of these expenses hit, you may be forced to turn to credit in the absence of any savings. That credit payment will make your budget even tighter.
The best way to avoid this is by having a few thousand dollars left over after you leave the closing table. And once you do, add a line in your budget to continue putting money into savings. Nothing can quite remove the feeling of being house poor like a well-stocked savings account!
Implement each of these strategies before purchasing your new home, and you can avoid the trap of being house poor.
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