What It Means to Be House Poor – and How to Avoid It

You’ve got your mortgage pre-approval, and you’re shopping the market for your perfect home. If you find one that’s priced too close to your limit, you run the risk of being house-poor. Let’s look at what it is, what you can do to avoid it, and what to do if you are already house-poor.

The Costs of Owning a Home

When you begin the process of looking for a home, you may think that the amount in your pre-approval letter and the house sale price are the only things that matter, but that’s not the case. There are several other costs associated with buying and maintaining a home that people often overlook:

Utilities – Your home needs water, electricity, and natural gas to run. You may also require utilities like internet and possibly city services like garbage pickup. Utilities are not factored into a mortgage payment, so you need to add them to your monthly budget or risk having your services turned off.

Property taxesSometimes property taxes are included in a mortgage payment, but sometimes they are not. If it is not included, you can visit the website for the property tax authority where you live and enter your home’s address to find out how much your property taxes will be every year.

Maintenance – It might not be tomorrow or the next day, but eventually, something will break in your home, and it will be up to you to repair or replace it. A new home likely won’t have this issue immediately, but if you live in an older home, it’s crucial that you maintain an emergency fund for the inevitable upkeep of the house.

Mortgage interest – If you have been following the mortgage rates as of late, then you are likely aware of the volatility in interest rates. Whether you hold an adjustable-rate mortgage or it is time to renew your conventional fixed-rate mortgage, you will need to understand that there is a chance you could pay more throughout the life of the mortgage.

The 32% Rule

Being house-poor means that you spend a large portion of your income on your mortgage and other housing expenses, leaving little for other costs. Canada Mortgage and Housing Corporation recommends spending no more than 32 per cent of your pre-tax income on housing expenses. To determine this number in your own circumstances, multiply your annual salary by 0.32. If you spend that amount or less on your home, then you should be in good shape. If you spend much more on housing, then you might be house-poor.

How to Determine Being House Poor

Are you unsure if you are house-poor? If so, the best way to figure it out is by calculating your debt-to-income (DTI) ratio. In other words, you can measure your earnings compared to your obligations by taking your monthly debt payments and dividing it by your income.

Here are two types of DTI ratios:

  • Front-End: This is the percentage of your major housing costs made up of your monthly gross income. Add your home expenses, divide by how much you make every month before taxes, and multiply the tally by 100.
  • Back-End: This considers all of your debts that go beyond housing and compares every minimum monthly payment to your monthly income.

Avoiding Being House Poor

Being house-poor can happen for any number of reasons. It could be that you did not take the extra expenses into account. Or perhaps there was a significant drop in income, making for a tight budget. Here are a few tricks to avoid becoming house-poor:

Budget ahead of time. Let’s be honest: acquiring a residential property is the most significant purchasing decision of your lifetime. You cannot be cavalier about it. Therefore, if this is your long-term objective, you will need to budget far in advance of the move-in date. Financial experts say to apply the 28 per cent rule: Set aside 28 per cent of your monthly income and put it in a high-interest savings account.

Erase your debts. Is this easier said than done? Perhaps. However, a mortgage will be your largest debt for the next 15, 20, or 25 years. As a result, you will want to decrease or eliminate your debt holdings to ensure you can maintain a mortgage while avoiding becoming house-poor. This can usually be done in various ways, including cutting back on non-essential expenses, consolidating your debts, and exploring other ways to earn money.

Make a larger down payment on the home. Not only will this give you more equity in your home, but it will make your mortgage payments smaller and save you thousands over the life of the mortgage.

Purchase a home that is less than your mortgage pre-approval amount. It may not be your dream home, but a smaller home will be more affordable. You can always upsize to a larger home when you’re financially ready.

Keep an emergency fund. You can never predict when something will break or if there might be a temporary or permanent income change. A dedicated emergency fund that is otherwise untouched could be the difference between living comfortably through a challenging time or being house-poor.

Skip adjustable-rate mortgages. While it might seem like adjustable-rate mortgages provide you with lower interest rates at the onset, they can typically lead to volatile monthly payments, making it harder to budget month to month. A fixed-rate mortgage provides more stability and ensures you accurately budget for the coming months.

Don’t fall for life inflation. When workers receive pay raises, they will adjust their living standards accordingly. This can be tempting, and many people fall into this trap, but you are better off dedicating the extra earnings to savings or your mortgage. This is one of the best ways to avoid being house-poor as you are preparing your household for income changes (good or bad).

What to Do If You Are Currently House Poor

If you have crunched the numbers and figured out that you are already house-poor, don’t panic. There are actions you can take to alleviate some of the stress and perhaps get you out of the poor house.

Get a second job. This is not always a practical action, especially if there are children in the picture, but a second job could give you the funds you need to keep your home and your lifestyle at their current level. Even a few hours a week at a part-time job or engaging in the “gig economy” can make a difference.

Find a roommate. Charging rent can increase your income, plus a renter will often pay for part of the utilities. If you don’t want someone living in your home permanently, you could consider renting out a room on Airbnb.

Trim your discretionary spending. This recommendation involves cutting your spending on a wide range of non-essential activities, such as visiting restaurants, heading to the local movie theatre, and travelling to exotic destinations. Instead of eating out three times a week, reduce it to twice and cook a nice meal at home. Or, rather than see the latest blockbuster at the cineplex, wait until it pops up on a streaming platform.

Dip into savings. This can be a hard financial decision, but using some of your rainy-day savings should be an option to help cover some of your monthly mortgage payments. It should be noted that this is not a long-term solution, but it can plug a gaping fiscal hole in the short term.

Refinance or downsize. If all else fails, it might be time to consider moving into a smaller home that will work better within your budget.

Being house-poor is a life circumstance that is stressful and avoidable. Do your research to ensure that you can afford home ownership, and take the steps necessary to get out of the situation if you find yourself house-poor.

Originally published on the RE/MAX Canada Blog.