While some argue that “owning a home is a keystone to wealth”, if you don’t tread carefully, you may end up in an uncomfortable financial position that could take decades from which to recover. Of course, with a steady income and a good credit score, any lender would be willing to finance your dream of homeownership—but at what cost? This is the most important question you should ask of yourself before filling requesting that mortgage pre-approval.
Homeownership—like any other purchase—should be approached with a great deal of consideration. The financial sages behind MoneyWizard recommend that you approach the whole premise of homeownership with an investor’s mindset. Your decisions should always be informed by facts rather than emotion (easier said than done when it comes to your primary residence, however). The right mindset can make the difference between a happy homeowner and a dissatisfied one that is always subject to money problems.
While one of the most popular types of mortgage is the 30-year, fixed-rate mortgage, buyers have other options, including 25-year and 15-year mortgages. As you can already tell, this is a long term financial commitment filled with tons of uncertainties. Losing your job, a divorce, children, expensive maintenance, or illness can easily knock you off-trac, rendering you “house poor”.
What does it mean to be House Poor?
Your new home comes with a number of new financial obligations for which you might not be prepared, including mortgage payments, property taxes, maintenance and upkeep, insurance, and utilities—among others. For the purposes of this article, we define being house poor as referring to a household that is overextended, spending 30–40% (or more) of their total income on mortgage payments, property taxes, maintenance and utilities. Households in this position often find it difficult to meet other financial obligations like student loans, vehicle loans, and credit card debts.
When you find yourself in this touchy financial position, you are deemed house poor, cash poor, or house rich (if it’s any consolation). While it may sound like an unlikely outcome, consider that almost one in every four Canadians live in a house that they cannot afford. Being house poor can be brought about by several factors—the most common of which is underestimating the total cost of homeownership.
There are tons of hidden or unforeseen costs that come with homeownership. When these costs stretch beyond the recommended ~33% of your gross income, your house becomes a liability.
Understand the Real Costs of Owning a Home
Most people rush into buying homes probably because there’s a child on the way, or they just want stable living quarters, and as it stands they can conveniently make the mortgage. As noble as these reasons may be, failing to account for the real costs of owning a home can easily drive you into becoming house poor.
As mentioned, the biggest pitfall new homeowners succumb to is failing to examine the true cost of owning a home. This “simple” omission can put them in one of the shakiest financial positions of their lives, with implications for future financial goals. A new homeowner should consider both one-time costs and recurrent costs before making the purchase.
Closing costs, which include appraisal fees, home inspection fees, land transfer tax, legal fees, and title insurance, account for ~4% of the purchase price (not an inconsiderable amount). Down payment, mortgage default insurance, moving expenses, upgrade costs, and utility installation costs also make up a significant chunk of the total.
Upon settling in your new house, you begin incurring house maintenance costs, property insurance fees, mortgage payment, monthly utilities, and property and school taxes among other related expenses. At this point, you haven’t yet added the living costs of the new house that include routine costs like groceries and clothing, costs of renovations, and your savings fund.
Taking time to run these numbers will save you a great deal of buyer’s remorse and the possibility of becoming house poor.
What Percentage of Your Income Can You Afford for Mortgage Payments?
As a general rule, your mortgage payments should never go past 28% of your income. Conservatives recommend devoting no more than 25% of your after-tax income to mortgage payments. The traditional model suggests dedicating nothing above 35% to cover your mortgage, property tax, and property insurance. This model further recommends keeping your total debt below 45%. The financial sages behind MoneyWizard maintain that you’ll be fine if you can strike a balance between the two models or stick to the one that makes more sense to you financially.
Make Sure You Have an Emergency Fund
An emergency fund is crucial for homeowners. While you might have crunched the numbers and arrived at the magic figure you need to be paying monthly for your new home, there’s no foretelling where the next surprise cost might spring up from. It could be a roof leak, a problem with the plumbing, your car breaking down, upgrading, or furnishing. This is exactly why you need an emergency fund that will cushion you against such uncertainties.
Ideally, you need an emergency fund of at least six to eight months of basic expenses if you’re to comfortably weather unforeseen costs in your new home, but you can always save as much money as possible for a rainy day.
When you find yourself stretched beyond your means and all the cost-cutting measures are doing little to rescue your situation, you may consider refinancing. Refinancing involves trading your old mortgage with a new loan with better terms, and possibly a new balance. This can afford you more money to spend on other discretionary items and perhaps lead a more comfortable lifestyle while servicing the new debt.
While buying a home is a sound financial and lifestyle decision, it should always be based on the reality of your finances to avoid getting yourself into a debt spiral— where you experience ever-increasing levels of debt, which will quickly become unsustainable.
Never make assumptions when you can work the math and decide whether a mortgage plan suits you or not. Consider that the more money you devote to paying for your home, the less you’ll have for other things. And there’s more to life than owning a home.
After all, it’s better to make cautious financial decisions around home ownership instead of pulling the trigger too quickly and becoming house poor. When you (and your finances) are really ready to own a home, you’ll know!
Additional Resources for First-Time Home Buyers
First-time home buyer? You probably have a lot on your mind. Thankfully, the financial sages behind MoneyWizard have got the resources, tips and financial support to help you on your journey!
Buying a Home in Canada: First-Time Home Buyers
- Start here! This step-by-step guide includes all the up-to-date information you need to help you make informed decisions and understand the home buying process in Canada… [Read more]
Are You Eligible For Incentives?
- To make buying your first home more affordable, the government offers numerous incentives— tax benefits, rebates, tax credits, or ways to fund your down payment. Find out if you’re eligible… [Read more]
How to Get Pre-Approved for a Mortgage
- Mortgage pre-approval is not only easier but faster than the mortgage approval process. It also expedites closing on a mortgage when you’re ready. In other words, a mortgage pre-approval is your true first step to owning a home. Learn how to get pre-approved today… [Read more]
How to Save Up for a Downpayment for a Home
- Depending on your strategy, successfully saving up for a down payment can be one of the most important steps in securing your financial future. It’s time to take the first step—we’ll show you how… [Read more]
How To Get a Mortgage With Bad Credit
- Lower credit scores attract higher rates—sometimes above ~10%. Regardless, you can still pursue your dream without waiting for your credit score to improve. And the financial sages behind MoneyWizard can help you obtain a mortgage—even with ‘bad’ credit…. [Read more]