What is “house poor”? This phrase describes home buyers who’ve purchased property they can’t easily afford—and are now paying the price, as it were.
“If you can’t spend your income the way you want to because so much of it is going to housing expenses, you’re house poor,” says Debra Neiman, a financial planner at Neiman & Associates Financial Services in Arlington, MA.
Translation: If you’re eating rice and beans every night just so you can pay your mortgage, you probably qualify.
As a general rule of thumb, financial advisers tell people to pay no more than 30% of their pretax income on housing—so if you make $5,000 per month, you should spend no more than $1,500 on your mortgage, property tax, and other housing costs. By that benchmark, according to the State of the Nation’s Housing 2017 Report from the Joint Center for Housing Studies of Harvard University, nearly 40 million households are house poor in the U.S.
So, now that you know what it means to be house poor, you’ll want to take some steps to avoid buying a house that’s outside your pay range.
How much mortgage can you afford?
When you’re buying a house, it’s crucial to consider carefully what size mortgage you can afford. One of the most basic equations you can use to figure this out is your debt-to-income, or DTI, ratio.
The DTI ratio is essentially a way for you (and lenders) to compare how much money you make with how much you owe—and how a house can fit into that picture. While mortgage lenders typically advise borrowers to keep their DTI ratio below 36%, Neiman suggests keeping it under 30%.
“If you buy at the top of your price range, you could be putting yourself at risk of becoming house poor,” she says. You can use realtor.com®’s home affordability calculator to see how much home you can afford while still remaining below your target level.
Nonetheless, the DTI ratio isn’t the only factor that mortgage lenders use when determining whether you’ll get pre-approved for a home loan. Your down payment and credit score are also important criteria.
How much it costs to buy a house
In addition to your principal mortgage payment, property taxes, and homeowners insurance, there are a number of lesser-known housing expenses that prospective home buyers overlook. These hidden homeownership costs include general maintenance, repairs, utilities, renovations, and household goods such as laundry detergent and toilet paper. How much you should budget for these expenses will depend largely on where you live. (These 10 cities have the highest costs of owning a home.)
You also need to have enough cash to cover closing costs, which typically total 2% to 7% of the home’s purchase price. You can get an estimate from your mortgage lender of what your closing costs will be before making an offer on a property, or plug your numbers into a closing costs calculator.
Why you need an emergency fund
Neiman laments that many home buyers don’t plan for unexpected life events that can damage their finances and, in turn, put themselves at risk of becoming house poor. For instance, what if you lose your job or have a medical emergency? Would you have enough cash to weather the storm while continuing to make your mortgage payments?
This is where the vital, yet often forgotten, emergency fund comes into play. Also known as a rainy day fund, an emergency fund should be a reserve of cash in a liquid account that’s large enough to cover at least three to six months’ worth of living expenses in the event you (or your spouse) lose your job. You can use an emergency fund calculator to see what kind of a financial cushion you want to have before buying a house.
A word of caution: While it’s wise to map out what your finances will look like five to 10 years from now, you still want to plan for the house you can afford today—not what you can afford a few years when your next salary increase kicks in.
How does home buying fit in with your other financial goals?
Before plunking down a huge chunk of your savings on a house, consider your other financial objectives. How will your mortgage payments affect your ability to save for retirement? If you’re a parent, will homeownership costs prevent you from co-signing for a college loan for your kid? Can you still pay off your credit card debt while juggling monthly mortgage payments? The last thing you want to do is stretch yourself so thin that you have to sacrifice other important financial goals.