Don't bite off more than you can chew.
If you watch homebuying shows on TV, you’ll often hear buyers saying they want to find their “forever home,” which means it’s large enough and has enough of their preferred requirements that they never plan on moving again.
However, if you don’t take anything else away from watching shows like House Hunters, I’d like for you to consider how many buyers who start off with a laundry list of must-have features end up choosing a house that didn’t meet their initial requirements. Buyers who didn’t even want to see a home that didn’t have a backyard pool end up choosing the house without the pool. Other buyers who declared they hated a house that needed remodeling eventually choose the house that needs a lot of work.
Sometimes, these buyers experience a reality check and figure out that their dream home and their budget cannot be reconciled. And they decide that they do not want to be house poor.
Go Big Or Go Home?
“Being house rich but cash poor is not a fun experience for a first-time buyer who may be building their business or even starting a family,” warns Julie Jones, VP of ultra luxury sales, and broker associate at Douglas Elliman Real Estate in Fort Lauderdale, Florida. She advises first time buyers to avoid disappointment and buyer burn-out by not even looking at properties that are significantly above their budget.
Agent Kate Wollman-Mahan of Coldwell Banker Warburg tells me that many people advise buyers to purchase as much house as they can afford, but she’s another realtor who encourages buyers to be more conservative. “Often people do not need as much space as they think they need, and they may have a house full of furniture and items they don't use or even want, or they may have several kids at home now who are only a few years away from going off to college.”
And, at least some people are listening, as some buyers are rejecting McMansions in favor of minimalist, simple-sized homes. Also, wages are not keeping up with housing prices, and buyers now need to earn six figures to afford a home without being house poor, according to Zillow.
While a house can provide tax benefits, future appreciation, and equity building, there are also some additional costs that aren’t discussed enough. “We cannot forget that there are maintenance costs as well as potential future increases in property taxes and insurance,” explains Mandy Phillips is a branch manager, and mortgage loan originator at Vista Home Loans in Redding, California. She tells me that she would never advise a future homeowner to completely wipe out their savings to purchase a home. “It's important to maintain an emergency fund in the event that something goes sideways with the home and/or in your personal life,” Phillips says.
Mortgage Lender Safeguards
Some first-time buyers may assume that their mortgage lender will ensure that they don’t purchase more house than they can afford. According to Melissa Cohn, regional vice president at William Raveis Mortgage, banks don’t want lenders to have a mortgage that’s too big or a monthly payment that’s uncomfortable.
“That is why banks have lending guidelines that borrowers have to meet so that they can afford to live in their new homes – and banks limit buyers to spending no more than 50% of their monthly gross income on a conforming loan and no more than 43% on a jumbo loan.” Cohn says banks understand that homeowners have other bills to pay – and that they don’t want to have to eat peanut butter and jelly sandwiches every day.
“In addition, banks require buyers to make a down payment - it can be as little as 3% of the purchase price, but they have skin in the game and are less likely to walk away from their investment.” In addition, Cohn says banks require borrowers to have money in reserve for a rainy day so that mortgage payments and living expenses can be paid if a job is lost.
She notes that these bank guidelines work most of the time. “The rate of default and foreclosures in the U.S. is currently less than 1% - I would say that is an amazing success rate.”
However, Jonathan Self, licensed COMPASS real estate broker in Chicago, Illinois, believes that one-size fits-all formulas like “X% of your monthly income,” don’t necessarily work for every buyer. “I advise clients to simply focus on the monthly number and not the big one at the end,” he says. “Behavior economics show time and again that consumers have a hard time really understanding large lump sums.”
Self advises buyers to consider what they can comfortably spend on housing each month, what would happen if they get sick, what would happen if they need to move, and what is the median rate of appreciation in the area to recoup closing costs.
And Phillips admits that lenders can’t predict the borrower’s future and whether they’ll lose their job or get sick, etc. “However, most mortgages are 30-year fixed-rate mortgages, and due to those stable, fixed payments, homeowners are able to budget more appropriately without the risk that their payment will skyrocket due to an unexpected rate jump,” she explains.
However, to avoid being house poor, Self recommends calculating the monthly payment you would feel comfortable making and then working backward, calculating the amount you would be comfortable with.
“Once you know the price range you should be hunting in, do not look above that range, don’t go to open houses when you don’t know the price, don't push your house search engine high, ‘just to see’ or any other number of ways people trick themselves into looking above their pre-set goal,” Self advises. “Just don't put yourself in that position, because that's a recipe for heartache at best, overleveraging from fear of missing out at worst.”
