Yahoo Finance 8 Common Mistakes That Can Make You House Poor
When someone is house poor, it means they’ve overextended their housing budget and now have little to no money left over for savings or other bills. Not only can this result in a lot of financial stress, but it can also lead to homeowners having to take on additional debt to cover their everyday expenses. Worst case scenario, it can even lead to major financial issues, like unpaid mortgage debt, foreclosure or even bankruptcy.
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Finding affordable housing is tough, and many people become house poor because they’re not prepared for the true financial burden of homeownership. Whether you’re thinking about buying a house or have already purchased one, it’s important to recognize the things that could make you house poor.
Here are some of the most common mistakes you can make that cause you to become house poor, according to experts.
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You Overextend Your Budget
One of the biggest reasons people become house poor is that they take out a loan at the top of their budget.
“Just because a lender thinks you can afford a house, doesn’t mean you’ll be comfortable making that payment each month,” said Joe Salerno, co-founder and chief investment officer at Yardsworth.
This doesn’t leave much wiggle room in the budget for unexpected or future expenses.
“If your situation changes, and you go from two incomes to one, for example, or have a new kid, you might find that last year’s ‘comfortable’ mortgage payment is the next 18-years’ ‘burden,'” Salerno added.
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You Spend More Than 30% on Housing Expenses
As a general rule of thumb, your total mortgage payment should be no more than a third of your take-home pay. But many buyers go with a higher payment, which can lead to financial hardship.
“Mortgage companies determine what you can afford based on your gross pay, but we all budget based on our take-home pay,” said Jay Zigmont, Ph.D., CFP, founder of Childfree Wealth. “Keeping your total payment, including principle, interest, taxes and insurance, under 1/3 of your take-home will leave you enough room in your budget for everything else.”
You Buy in a Neighborhood With Minimal Liquidity
Real estate is an investment, but not all properties are created equal when it comes to the returns. If you purchase a home in an area where homes aren’t really selling, you could end up with a bigger financial problem later on.
“If one buys a house that has very little liquidity, meaning that few houses are able to sell on the market and there is typically lots of inventory, one may find themselves in a position where they have to stay in that house and do not have any other options,” said Sebastian Jania, the owner of Ontario Property Buyers.
And if that same homeowner is in a situation where they need to sell their property quickly for some cash but can’t, they couldn’t end up financially strapped.
You Take on a Variable-Rate Mortgage
Variable-rate or adjustable-rate mortgages (ARMs) have their advantages. In particular, the variable rate is often lower at the start of the loan term.
The problem with variable-rate mortgages is that the interest rate can change over time. This makes it hard to predict your monthly mortgage payments, and it can lead to you becoming house poor.
“If you took out a 3/1 ARM back in 2020 or 2021, or a 5/1 ARM back in 2018 or 2019, you’re now facing one of the most dramatic changes in mortgage rates we’ve seen in a generation,” said Salerno.
“Look at how quickly mortgage rates have changed — they have more than doubled since 2020,” he continued. “If your $800,000 mortgage — a ‘starter home’ in California — changes from 3% to 7%, for example, your payment is increasing by $1,950 a month. Talk about feeling house poor!”
Your Down Payment Is Too Low
You might be able to buy a home with a down payment as low as 0% with USDA and VA loans. You might even qualify for a mortgage with as little as 3% to 5% down.
But even though a smaller down payment might make it easier to get a house sooner, it can end up costing you.
“Your goal should be to put down 20% as a down payment. A 20% down payment means you will be able to avoid private mortgage insurance (PMI) and lower your monthly payment,” said Zigmont. “You may be able to buy a house with a lower down payment, but it may result in you being ‘under water’ the day you buy the house.”
You Take on a HELOC
Home equity lines of credit (HELOCs) are variable-rate loans that let you tap into your home equity. Generally speaking, it’s best to take advantage of low interest rates when getting a HELOC or any other variable-rate loan.
But if you take out too large of a loan and rates increase, you could end up with a much more expensive debt than you imagined.
“When you’re sitting on record amounts of home equity but don’t have cash in the bank, a HELOC can sound like a great idea,” said Salerno. “Unfortunately, HELOCs are variable rate instruments, typically tied to the prime rate — which has shot up over 5% since 2020.”
“Imagine that you took out a $300,000 HELOC in 2020 to build an ADU [accessory dwelling unit] in your yard,” he continued. “Today, you’re losing money on that rental, because your monthly payment would have doubled from [about] $1,300 a month to over $2,600! It’s great to tap into the value in your backyard to build housing, but not by taking on a variable-rate loan.”
You Have a Lot of Other Debt
Whether it’s high interest credit cards or student loans, having a lot of other debt can make it harder to manage your housing payments. And if you end up taking on even more debt after getting a mortgage loan, there’s a higher chance of you becoming house poor later.
Zigmont suggested getting out of debt before getting a mortgage. “Your goal should be to have no consumer debt before you buy a house. This is particularly true about any credit card debt.”
You Don’t Shop Around or Negotiate
As a homebuyers, you have a lot more negotiating power than you think. This is true when it comes to putting in offers for a home. It’s also true when it comes to shopping around and negotiating for better rates. But if you don’t do these things, you could end up financially strapped.
“Shop around for the most competitive bids to ensure you are not overpaying for homeowners, earthquake, flood and other insurance,” said Elizabeth Dodson, co-founder at HomeZada.
The same goes for utilities, maintenance and other everyday home expenses.
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