The following is a post by MPFJ staff writer, Kevin Mercadante, who is a freelance professional personal finance blogger for hire, and the owner of his own personal finance blog, OutOfYourRut.com. He has backgrounds in both accounting and the mortgage industry.
Mortgage lenders operate with a litany of guidelines within which they will make loans to homebuyers. But here’s a newsflash: the fact that you qualify for a mortgage under those guidelines won’t protect you from becoming house-poor. It’s important to understand that mortgage lending guidelines aren’t necessarily designed to make sure that you can comfortably afford to own a certain home. No, they’re mostly aimed at stimulating homeownership on a national level. That may not do much good for your own personal finances.
Why should you worry about becoming house-poor? Apart from the very real possibility that it can land you in foreclosure, it’s not a very comfortable way to live.
Picture these scenarios:
- You’ve been faithfully cooking your meals at home for two weeks and would like to go out to dinner on Friday night – but you can’t, because the house payment is due on Monday and you’re already squeezed
- You need to get braces for one of your kids, but you put it off because the house needs a new roof
- You’re about to forgo summer vacation for the third year in a row, because the house payment and utilities are eating up any extra in your budget
- You’re having trouble paying down your credit cards, because there’s simply no fat left in your budget to cut
- Your emergency fund is empty, and has been for months
These are very real situations that can develop when too much of your budget is tied up in your house. For that reason, here are seven ways to keep from becoming house-poor. Most of them involve making a smart purchase decision upfront.
1. Buy a House That’s a Little Beneath Your Means
Forget about the $600,000 McMansions that all of your friends seem to be buying. If you qualify to buy a $300,000 house, buy a $250,000 house – or even a $200,000 house – instead.
Understand that the amount that you pay for your home will set in motion a long list of expenses, many of which will be directly or indirectly tied to the price of the home. Property taxes are a prominent example, but so is homeowners insurance. And since a higher price generally means a larger home, your utilities will be higher as well.
You can avoid the major factors that lead to being house-poor just by being more conservative in your choice of a home purchase. You will only have one opportunity to make that smart choice – don’t let it pass!
2. NEVER Close Broke!
I realize that it is virtually the American Way to break open every last cookie jar in order to buy a house. Unfortunately, if you’re broke when you leave the closing table, it could set a pattern in motion in which you’re perpetually broke thereafter.
The common mortgage lender guideline is that you have two months “reserves” after closing. In mortgage parlance, this means that you should have liquid assets equal to at least two months of your new house payment. But that’s pretty minimal.
A better idea is to go with the consensus on an emergency fund, that you should have at least three months of living expenses – which includes your new house payment – sitting in a very liquid account. And once you are in the house, keep that emergency fund growing – along with other savings vehicles.
3. Keep Your House Payment to Not More than 28% of Your Income
A common mortgage industry guideline is that your house payment should not exceed 28% of your stable monthly income. However, mortgage lenders will often allow you to exceed this percentage for various forms of “good behavior” in other areas of your financial profile (good credit, large down payment, long employment history, etc.).
The best advice however is to view the 28% guideline as the upper limit of your house payment, and not as a limit that you want to exceed. Even at 28%, more than a quarter of your gross monthly income will be going just for your base house payment – and that’s a lot to allocate for a single expense, even housing.
4. Keep Your House Payment Well Below 28% of Your Income
Forget about what a mortgage lender will allow you to do, set your own house payment limit, and make sure that it’s below 28%. Make it 25%, or 20% or even 15%. Always remember that the less of your income that is going into housing, the more you will have available for investing, for paying off debt, and for living the non-housing part of your life.
5. Qualify on Your Base Income Only
This is another area where homebuyers stretch the limits, and where mortgage lenders are perfectly willing to cooperate. They will often include extra income, such as bonuses, occasional commission payments, or a part-time job or business as part of your qualifying income.
The better strategy however is to qualify on your base income only. That will match up best with a fixed monthly payment, since it is almost certainly the most stable and predictable source of your income. That will also free up the extra income sources to handle contingencies and for non housing expenses.
6. Qualify Based on a Single Income
If you’re a couple, and each of you has an income, qualify on one income rather than on both. There are several advantages to this approach:
- In the event that one job is lost, you’ll be able to comfortably survive on one income
- Should a child arrive in your household, one partner would be able to handle the child-rearing responsibilities, without threatening family finances
- If one of you decides that you just need some time off, you can take it without fear that you might lose your home
I’ll admit that this is an unconventional way to qualify for buying a home, but it involves taking a more considerate view of what can or might happen in the future. And it builds flexibility into your finances – which is always well advised.
7. Keep Your Non-Housing Debt to a Minimum
Buying and owning a home is almost always more expensive than renting. Even if the house payment itself isn’t higher than rent, it’s still almost certain that your utilities will be higher, as will maintenance and repair costs, to say nothing of periodic major repairs.
For that reason, your non housing debt needs to be at an absolute minimum when you buy a home. Rest assured that if you are struggling with debt payments before buying a home, it won’t get any better later. And if you end up having to tap credit lines to pay unexpected housing expenses, the debt problem can get progressively more intense.
Payoff as much debt as you can before buying a home, and vow to become debt free, or as close to it as possible while you are a homeowner.
One final thought – it’s much easier to become house-poor than it is to escape it. So take at least some of these strategies and put them into action early in the game. Your future self will deeply appreciated it!
How about you all? Do you have other tips that have helped you or someone you know avoid becoming house-poor? What has or hasn’t worked for you in the past?
Share your experiences by commenting below!
***Photo courtesy https://www.flickr.com/photos/shankaronline/11932005065/sizes/q/
