1. Many people over the past 5 years who bought homes thought they were getting rich by buying bigger homes. Many were told that homes always went up in value and that they needed to get into the market as soon as possible before prices went up more. With history on your side, buying a home was the safe bet because they were going up in value across the U.S at an alarming rate. Little did the home buyer know, that they were about to become house poor.
2. House poor is a relatively new term. You never really heard any terms like negative amortization mortgage, option arm loans, or adjustable rate mortgage before the refi boom. They became common place during the refi boom and were supposed to be good home loans. Unfortunately they were some of the worst loans ever. Nothing can ever beat the 30 year fixed interest rate mortgage.
3. So what is house poor? House poor is a combination of factors. The biggest factor is for people who are either first time home buyers or people looking to upgrade and move to a bigger home. When looking at all of their options they are told from their realtor and their mortgage banker to get approved for the biggest loan amount that they can. When you buy a bigger home you bring on more debt and expenses. Bigger home loan, bigger utility bills, more costs for upkeep,etc. House poor is when you make enough money to make the payments on your things like your house, cars, boats, student loans, and credit cards but cannot save any money for retirement, a trip, kids college funds, money to go out for dinner, or money to see a ball game. Everything looks good on the outside. You have a big house, nice cars, boat (maybe) but you are one missed check away from total financial disaster. If you were let go from your job tomorrow you would be screwed. Smart financial people would rather take a smaller house with a smaller mortgage payment and have money left over to play with.
4. As most of us know, realtors work on straight commission. So when you hear a realtor say “buy the bigger home” or “the one with all of the upgrades” you really need to step back. Of course they are going to say that. The difference on a $100k or $200k house is $6k more in commission for them. That is a ton of money. On the mortgage banker side, they also get paid a percentage of the loan amount. The bigger the loan amount, the bigger the commission check for them. Most of the times the mortgage banker will love to see you buy the bigger house but does not really care. What most of them do is tell you what you can be approved up to and then its up to you to work your way down from that number. The realtors for the most part are trying to find a home for you regardless of the price because they also want a sale. Do not fall for the “you’ll probably be making more money as your progress in your career” or “now you will never have to move.” Those are both ways to make you comfortable with buying a bigger house. Last time I checked homes were foreclosing all over the country and there are layoffs going on in every single industry. Might be hard trying to make payments on that larger house or even trying to sell it.
5. Going into your home search you kind of have an idea of what you can afford. Most people who are first time home buyers want to keep their first mortgage payment around what they pay for their rent payment. This is a good practice but what most home buyers forget is that all of those things like a hot water heater going out, cutting the grass, fixing the roof, and all other repairs add up. All of those things are just one call away to the apartment manager and they call a guy to come and fix it. Nothing comes out of your pocket for those expenses. When it happens in your home you have to pay for all of those out of pocket and still pay your mortgage payment. Expect to double your mortgage payment just in monthly maintenance and up keep to your house. I hope your starting to see why you do not own the home, it owns you.
6. When you buy a house that is at the maximum amount that you are approved for you have already began to handcuff yourself to this house. During the height of the refi boom, some people could get approved for mortgages with a debt to income ratio of 55% depending on their credit score. This means 55% of what is showing on your credit report is going to pay your new mortgage payment plus any car and credit card payments. This does not take into account things like car insurance, gas for your car, maintenance for your car, gas for your lawn mower, heating bills, water bills, cable bill, phone bills, etc. These are probably the largest of the bills that are not on your credit report. I bet if you added all of those up on top of your mortgage payment you will start to kick yourself because now you probably do not have anything left over for anything. You are now working for your house.
7. Here is a quick example. You and your spouse have a combined income of $125k a year. You pay $700 a month for car payments and $300 a month for pesky student loans. You do not carry any credit card debt at all and you have outstanding credit. You have saved up $30k in a savings account to be used for a down payment and have about $25k between 401k’s and retirement accounts. You currently pay $950 a month in rent. You are a first time home buyer and want to find something with a similar monthly payment. You call up your mortgage broker and tell him what your looking for. He says what you are looking for would be a home worth $125k. You can put 20% down of $25k and have $5k left over for closing costs. You decided to pay your property taxes and home owners insurance separately so you do not need to have anything for an escrow account. Your loan would be for $100k and lets say interest rates are 7% and if you were paying an escrow it would be $400 a month. Your principal and interest is $665 plus escrow of $400= $1065. This is still about a $100 more a month than what you were looking for but not bad since you get to write your taxes, insurance, and interest off on your taxes. Your debt to income ratio is calculated by adding all of your out going bills on your credit report $1065 + $700 + $300 =$2065 then dividing by your monthly income of $125k/12 months= $10,416. You get $2065/$10,416=19.8%. This is great. You will have more than enough money to save, make your payments and have enough money for repairs and upkeep.
8. But you really like that bigger, newer house the next street over. It has all of the upgrades you could ever want. You decide its the home of your dreams. Your realtor starts to smile because they know that you have sold yourself on the bigger house which means a bigger commission for them. You call your mortgage broker back up and ask them what the maximum amount you could get qualified on would be. Using the example above you could get approved for a home roughly in the $350k range. You could put your entire $30k down payment into the house and negotiate sellers concessions so they cover your closing costs. Your $30k only covers about 8% of the down payment which gives you a loan to value of 95%. You decide to only put down 5% and use the extra for closing costs. Your new monthly mortgage payment on $332,500 at 7% now includes private mortgage insurance (PMI). This will probably be another $200 or more (probably $400) a month and it is because you did not put 20% down payment. Your new payment is $2,212 + $200 (PMI) + escrow of $400 (it will probably be $700 because of the house value)= $2,812. To figure your DTI you have the $2,728 + $700 (cars) + $300 (student loans) = $3728. Your new DTI is $3728/$10416= 35%. As you can see this still sounds pretty good. I was saying how mortgage companies were approving people up to 55% DTI.
9. The thing of it is that the mortgage company has a way of making you think your approved for the loan. What they look at is your income before taxes to get you approved on a mortgage. They need all the income they can get to get you approved and this is why they do it. They need to close loans to stay in business. So those DTI numbers above really do you no good. What you need to do is take your combined family income of $125k and take out at least 15% which is probably what your income tax bracket is, i.e $18,750. Then use $125k-$18,750 = $106,250 to figure what your after tax income ratio. Now you have $106,250/12 months= $8,854. Using our first example of $2065 you get $2065/$8854=23.32% DTI. Still not bad. On the second one you get $3728/$8854=42%. Big difference. What you need to ask yourself is that if you are okay knowing that almost 40% of what you make in your family only gets you the keys to the house and your cars. This does not include operating them, just the keys. When you add up all the other costs like I did above you will see that by getting the bigger house you are probably going to have 5% of your monthly income laying around for saving and entertainment purposes.
10. Americans were very greedy during the housing boom. Homes were being sold at inflated prices. People assumed that home prices would keep going up and decided it was the time to buy bigger because they would never be able to afford the house later. The sad thing is that they could not afford the house at the time they closed on it. Underwriting guidelines were to relaxed. Everybody was getting approved on loans. Not only were they buying homes, they were taking advantage of 0% car loans and other things they did not need. I always get a kick out of the people that have a big house, nice ,cars, and lots of things they do not need and complain about HAVING to work 60-70 hours a week. I smile and wonder if they would be happier without the bigger house. They probably would but nobody will admit it. As long as we can show off to one another what we have this “house poor” phenomenon will continue.