For most people, becoming a homeowner is a great opportunity. You get to build equity, plan for the future and decorate your home however you wish. But if you buy before you’re ready – or buy too much – then you can end up house poor. First-time buyers are likely to encounter this term as they move through the home buying process. Even if you’re not familiar with the term, you’ll probably know someone who has experienced or is experiencing it. Do you know anyone who owns a 3-bedroom apartment but can’t pay their credit card bill? That’s what being house poor looks like. Read on to understand how people become house poor and what you can do to avoid it.
What is being house poor?
Being house poor is when a homeowner finds themselves spending a large amount of their income on housing expenses such as their mortgage, utility bills, homeowner’s insurance, and property taxes. Once all these expenses are paid, they have little left over to pay other financial obligations outside of homeownership. The usual benchmark by which someone can be called house poor is if they’re spending more than 30% of their income on housing expenses. For many people in NYC, they’re spending a lot more than that!
Whatever the exact benchmark, it’s a really bad situation to be in. It can happen when there’s a sudden drop in income or when there’s an unexpected life event or emergency. Others can create the situation by buying too much house or not being fully prepared for the costs of homeownership. If you find yourself on the road to going house poor, then you are facing serious financial risk. The best way to avoid it is to have a little patience and make sound financial decisions. Here’s how to do that.
1. Don’t buy more than you can afford
The easiest way to avoid becoming house poor is to stay within your budget when buying a home. The general rule is that you should pay no more than 30% of your monthly income on housing expenses. They key to doing this is not taking out more than you should on a mortgage. Keep in mind; your mortgage pre-approval is based on your gross income, not your take-home pay. Calculate what your monthly housing expenses will be and subtract that from your take-home pay. If what’s left isn’t enough to cover your current lifestyle then either reduce your lifestyle expenses or settle for a smaller home.
2. Build up your savings
A prime rule to follow (which many buyers don’t) is to make sure you have emergency savings left over after a home purchase. You never know when a medical emergency might strike or if you’ll suddenly lose your job. The situation needn’t even be as drastic as that. As a homeowner, you’re responsible for making all repairs. If your boiler breaks down in the dead of winter, you’ll want to have the funds needed for repairs. Aim to have at least 3-6 months’ worth of living expenses saved up before you sign that purchase contract.
3. Avoid lifestyle inflation
There’s nothing wrong with treating yourself a bit after a salary raise. Just watch that you don’t allow it to affect your ability to meet your monthly expenses. Try to reel yourself in and avoid overly increasing your lifestyle expenses. Instead, you should be putting that extra money into your savings account or using it to pay down the principle on your mortgage.
4. Be realistic about renovations
If you don’t mind fixing up a place for a reduced price, then look into buying a home as-is. Just be aware that the costs of renovations can quickly spiral out of control. Any estimates that private contractors give you for a job are just that: estimates. Further problems might be uncovered as the work progresses, leading to your savings drying up faster than you thought possible. Stay realistic about the size and scope of any renovations you might have to undertake. The same goes if you’ve already bought the property and want to make some upgrades. If you don’t have the funds to handle renovations (and leave savings left over), then it’s better to put them on hold or spread out your expenses over time.