Nobody plans on becoming house poor. Often, people become house poor when they have just enough money to buy a house, but then struggle to afford the additional expenses that come with homeownership. “When your housing is half (or more) of your pay, you may not have enough money for basic needs, never mind having money for saving or enjoying,” Jay Zigmont, PhD, CFP, and Founder of Childfree Wealth, said.
Example of House Poor
Let’s say you bought an older home at the very top of your price range. When you bought the house, you did the math and knew you could afford to pay the mortgage, property taxes, and insurance. When purchasing the older home, however, you did not take into account how much extra maintenance work would be expected. And the square footage in this home is much larger than your previous home, so you’ll eventually need to purchase additional furniture. After several months in your new home, you realize that the expenses are much higher than you originally anticipated. The majority of your income goes toward taking care of the house, leaving little money left over for anything else. In this case, you would be considered house poor.
How To Tell If You’re House Poor
According to Jon Sanborn, co-founder of Brotherly Love Real Estate, being house poor can negatively impact your financial situation, and often leave little funds left over for investments and savings. Calculating your debt-to-income (DTI) ratio is one way to determine whether or not you’re house poor. In general, experts recommend your DTI ratio to be less than 36 percent. For example, if you make $60,000 a year, or $5,000 a month, you should ideally keep your debt below $1,800 a month. That means if you have no other debt, you would pay no more than $1,800 a month on your mortgage. If you have other debt, like a student loan or auto loan, you’ll need to take that into account as well. If you’re already paying $200 a month in student loan debt, you should ideally keep your monthly mortgage payment at $1,600 a month or less.
What To Do If You’re House Poor
There are a few ways you may be able to reduce your monthly payments that go toward homeownership, including consolidating debt or refinancing. Learn more below.
Consolidate Debt
If you have outstanding debts in addition to your mortgage, you may be able to consolidate debt into one loan. You could take out a debt consolidation loan that you use to pay off your current debts, or make a credit card balance transfer. If you choose to consolidate your debt using a home equity loan, keep in mind that you may lose your house if you don’t pay it off.
Refinance
If you’re able to get a lower interest rate now than when you first took out your mortgage, you may want to refinance your home. It’s often a good idea to refinance if you can get an interest rate that is at least 1% lower than your original interest rate. In that case, you’ll most likely save money on monthly payments. If you have 15 or 20 years left on your mortgage, for example, you might want to refinance to change the length of your loan term. A longer loan term will lower your monthly payment, although it typically means you ultimately pay more in interest.
Get Another Job, If You Can
Having an additional stream of income can help you reduce your DTI ratio and make expenses feel more manageable. If you have the time and ability to do so, consider taking on additional work. Some examples to consider include tutoring, dog walking, or any other type of work you can do in your off-hours.
Sell Your Home
If you’re spending more than you can afford each month, you may want to look into changing your living situation by selling your home. If you can expect to save a significant amount of money on monthly payments by renting, you may consider this option until you can save up for a larger down payment. Or, you may consider purchasing a less expensive home, or one that requires less upkeep.
Get Rid of PMI Payments
Once you have 22% equity in your home, your private mortgage insurance (PMI) loan will be automatically canceled. However, you may be able to stop your PMI payments before that. If home values have increased dramatically since you purchased your home, you may want to have your home reappraised. You might also want to take out a home equity loan, or HELOC, and use that to pay off enough of the down payment on your primary mortgage to stop making PMI payments.
Reduce Discretionary Spending
If money still feels tight while your DTI is less than 36% and you’re spending no more than 28% of your income on housing costs, you might want to review your budget and monthly spending to see where you can cut back. Some wants to consider temporarily removing or reducing from your expenses include monthly subscriptions and dining out.
How To Avoid Becoming House Poor
As a homeowner, there are a few ways to avoid becoming house poor. The main one is to ensure you have a realistic picture of your day-to-day expenses, as well as housing costs.
Budget
Sanborn recommends utilizing the 50-30-20 budgeting method—put 50% of your income toward housing and other necessary expenses, 30% of your income toward leisure, and the remaining 20% can go toward savings and investments.
Don’t Over Finance
Zigmont recommends keeping your monthly housing costs, including your mortgage payment, taxes, interest, and insurance, to less than one-third of your take-home pay. Most banks will approve you for much more than that, so it’s important to know what you can actually afford.
Be Realistic When Purchasing a Home
To avoid being house-poor, Zigmont recommends only buying a house when you can truly afford to do so. “You are in an excellent place to buy a house when you have no consumer debt, a three to six month emergency fund, and a 20% down payment,” he said.
