There’s a term called house poor, and it’s something you absolutely want to avoid.
When you hear someone saying they’re house poor, it means they’re spending a significant portion of their income on all-things related to housing. This can include their mortgage payments but also maintenance, utilities, insurance, and taxes. When you’re house poor, you can’t afford many other things, and certainly not big extras like vacations.
Being smart when you buy a home and knowing what you can realistically afford can help you avoid being house poor.
There are a few mistakes people commonly make in their home search that increases the likelihood they may feel house poor. One is simply being overly ambitious during the homebuying process and taking on a loan that’s too big. Another big mistake is thinking only about mortgage payments and not anticipating the other expenses that go into homeownership.
The following are ways to get a home you can reasonably afford and lower your risk of being house poor.
Crunch the Numbers
Before you ever start the actual process of shopping for homes, look at the numbers.
You’ll need to take into account how much you earn every month, as well as your partner’s earnings if applicable.
Then, outline all of the housing costs, which include:
• The down payment
• Property taxes
• Homeowner’s insurance
• Utilities and maintenance
Tally up all of the expenses that you currently have and have to pay out each month. Then, look at your discretionary spending and include that as well. Including that discretionary spending is important and sometimes overlooked. It’s those extras that you want to be able to continue to pay for, even when you buy a home.
Follow the 28/36% Rule
Many financial professionals advise that you spend no more than 28% of your gross monthly income on your housing expenses. You should also plan to spend no more than 36% on your total debt, including not just your home loan but your credit cards, car loan, and student loans.
Some of the things that you should think about beyond your income and expenses include:
• How much savings do you have set aside? You want to have a reserve of cash in case something happens, and if your down payment or mortgage costs are going to dip into your savings, it’s problematic. Your mortgage may also affect how much you can set aside in savings or retirement, so this is something to think about.
• How much of a down payment can you afford? The traditional wisdom is that you put 20% down, but there are loans with options to put as little as 3% down. That’s going to raise your payment, however.
• Is there a different type of mortgage outside of a traditional bank loan that you might qualify for? For example, FHA loans are backed by the Federal Housing Administration and you may qualify with a lower credit score and down payment compared to a traditional loan.
Take Steps to Get a Competitive Interest Rate
Interest rates are historically low right now, which is likely why the real estate market has been strong despite the economic fallout of the coronavirus. Even with rates low, you should take the time to put yourself in a position to get the most competitive possible rate.
Your credit score is going to either help you or hurt you as far as getting a low interest rate.
Before you buy a home, look at your credit report, and clean it up if necessary.
Try to minimize how much debt you have compared to your income. You also want to lower the ratio of credit utilized to credit available..
Err on the Side of Caution
When you start looking at homes, you should always err on the side of caution. Keep your house hunt focused on the lower end of what you can technically afford.
If you’re a first-time buyer, it can be tempting to want to go all-in with the belief that you’re buying your forever home. Your life can change over the years, and your first home is probably not your forever home.
Focus on a starter home that works for your current needs to protect yourself from being house poor.
You can’t just think about your current income either. Think about what might happen if you lost your job or your partner lost their income. How would that change the equation?
Finally, one option that can help you better stay within your budget is buying a fixer-upper. You can find a great deal, and then you have the option to gradually create the home of your dreams as your budget allows, rather than having to go all-in right away.