Homeownership is the quintessential American dream — but over the last several decades, it has become less and less affordable. According to Harvard’s Joint Center for Housing Studies, home prices are rising faster than our incomes. In fact, the national price-to-income ratio sits at 4.4, or 4.4 times a homeowner’s income — the highest point since 2006.
We’re paying a price for this — from struggling to stay in our homes to wondering whether we can afford to buy a home at all. Across the U.S., more than 2 million homeowners are behind on housing payments and are thus at risk of foreclosure. Beyond that, as the cost of homes rises, so does the entry point for homeownership — and younger households or those with lower incomes are being left behind to a larger degree, widening the homeownership gap.
These conditions can lead to us being house poor.
What Is House Poor?
In simple terms, someone who is house poor spends too much money on their housing expenses — from the mortgage payment to property taxes, utilities and needed repairs or upgrades. In the housing industry, such a person is deemed to be “cost-burdened.”
What does it look like, then, not to be cost-burdened? It is becoming increasingly complex to define what affordable housing looks like, but there are a few important factors to weigh.
1. Percentage of Gross Income Spent on the Mortgage
There’s debate about how much a household should spend on shelter. The U.S. Department of Housing and Urban Development defines affordable housing as a residence that costs no more than 30% of its residents’ gross, or before-tax, income. This guidance has roots in an amendment to housing legislation from 1969 called the Brooke Amendment.
Today, many people are finding the 30% rule increasingly difficult to live by, in part due to growing costs in other areas of their budgets. Approximately 43 million Americans now have student loan debt, with a total of $1.7 trillion owed. Older adults are living with their adult children to a growing degree, and the number of three-generation households that include at least one person age 65 and over went from 1.7 million in 2006 to 3.2 million in 2016. The number of parents caring for a child with a disability has risen, as the disability rate among children increased 0.4 percentage points between 2008 and 2019.
Despite all of these growing expenses in people’s lives, income growth has been fairly stagnant, increasing just 0.3% annually on average.
In her 2005 book “All Your Worth,” Sen. Elizabeth Warren proposed new guidance: 50% of income to fixed expenses, 30% to discretionary purchases and 20% to savings and investments.
2. Debt-to-Income Ratio
Mortgage payments, either taken alone or as a factor in your fixed expenses, are not the only variable that will determine whether a home is affordable for you. The amount of debt you carry matters, too. Most lenders will look at what is called your back-end debt-to-income ratio. They’re generally looking for a debt-to-income ratio of 43% or less.
3. Credit Score
Your credit history helps determine your credit score, which then helps determine the interest rate that you’ll pay on a home loan. In general, the higher your credit score is, the more eligible you will be for the lowest possible interest rate on a home loan.
4. Asset Holdings
Last, but not least, your ability to afford a home depends in part on the size of your safety net. The amount of money that you’re able to save for a down payment, as well as the amount you’ll have left in savings and investments, will determine whether you can afford the home’s price of entry, the ongoing cost of maintenance and the hardships that you could potentially face while living in the home, such as the loss of a job.
How Many People Are House Poor?
More than 2 million homeowners are behind on their mortgages and in danger of foreclosure. Far more are likely house poor, meaning that they’re potentially at risk of falling behind.
The Real Cost of Homeownership
According to personal finance expert Suze Orman, most people make the mistake of pursuing a mortgage payment equal to their current rent payment. This is a mistake, she told CNBC Make It, because it neglects to factor in property taxes, maintenance and insurance.
The Risks of Being House Poor
Many people find that being house poor is uncomfortable — but there are more serious consequences.
Loss of Home Equity
The first place that many homeowners turn to for cash is their home’s value. For example, if you have a $250,000 home and you’ve paid for $50,000 of it via your down payment and monthly mortgage payments, then you have $50,000 of home equity. Many lenders will allow you to borrow against that equity, but it may not be advantageous unless you have an action plan for paying it back in full.
When you are house poor, you may feel tempted to refinance. While refinancing can be useful in some situations, it’s important to be careful about the lender you choose to work with and the terms of the deal you agree to. Predatory lending practices can involve unusually high interest rates (in some cases, higher than the one you were paying initially), high fees — some of which may be hidden — prepayment penalties, balloon payments and packing your loan with unnecessary extras like credit insurance, reducing your ability to pay off the loan’s interest.
You may also find yourself turning to personal loans, which potentially involve similar dangers.
In the worst-case scenario, a house-poor homeowner can face foreclosure if he or she falls behind on mortgage payments and is unable to catch up quickly. Foreclosure will force you to leave your home, lose any money you put down on it and deal with other potential fallout, like an impacted credit score.
Good To Know
If you’re looking to buy a home, aim to make a down payment of at least 20%. If you don’t, you will need private mortgage insurance, which will increase your housing costs for months or years.
Recommendation: Redefine Security
Few things make a person feel more secure than the roof over their head, so the collective drive toward homeownership is logical. However, one lesson to be learned from the financial crisis of 2008 is that homeownership comes with inherent risk. Those who understand the overall economic climate, the risks of being house poor and the steps they can take to avoid that outcome have the best chance of security.
GOBankingRates’ Homebuying Guides
- 7 Things You Should Know Before Buying a House
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- Home Inspection Costs and Why You Need One
- House Hacking 101: Top Tips and Advice
- Home Inspection Checklist: The Ultimate List of Items to Look For
- How To Flip a House: Your Step-By-Step Guide
- What Is Mortgage Insurance and How Does It Work?
- How To Refinance a Mortgage
- Mortgage Closing Costs: What They Are and How Much You Can Expect To Pay
- How To Find Small Home Loans Under $50K
- How To Rent Out a House in 9 Steps