|By Sarah Carlson, CFP®, CLU®, ChFC®|
Being house poor is increasing as real estate investing has been a hot asset class lately since the demand is more significant than supply. Prices have been going up, up, and up. With interest rates still low and lending so easy, it has helped to fuel this hot real estate market. New homeowners can afford higher sales prices with lower interest rates. But I know when anything gets too hot, you can and will get burned.
Why am I pulling the alarm? Now is the time to be careful not to rush into a large purchase such as a home that you may later regret. I have often seen new homeowners get into a real estate investment they cannot afford. Too many times, new homeowners will spend all their discretionary income on mortgage and property-related expenses that they have no buffer for emergencies, much less fun. All those other expenses are going up with inflation.
Too many times, I have seen homeowners use their house as a piggy bank. How does this happen? A bank is very willing to loan a home equity line of credit (HELOC) for the loan is secured against the borrower's equity in their home. For the borrower, it's straightforward. If real estate values go up, they have more equity, their banker then will extend credit on demand, and the homeowner has an easy fix for their short-term cash needs such as:
- Did your kitchen remodel go over budget?
- Didn't budget for your child who is going to college?
- Have you and your spouse been pent up from the pandemic, just ready to bust loose on vacation?
No problem, tap into your HELOC. Well, that HELOC seems pretty easy, right? WRONG! It's terrible for so many reasons.
First of all, your house should not be your piggy bank. Selling your home will not make you rich, for when you sell it, you most likely will still need to buy something else. What does happiness and homeownership mean for you? I have never seen people wanting and planning for a lower standard of living, but when you use your home equity to fund your lifestyle, that is what you are doing.
Being house proud will most likely get you into problems if you borrow beyond your means which leads to becoming house poor. Your lender needs to be paid back, and when you can't make payments, they will take your home, and you may not see any value in return. Real estate values fluctuate, and I think we are very due for a pullback.
Instead, here are some considerations I want you to consider:
- When you find the home you want to buy, do you understand the other costs such as property taxes, homeowners association costs, and utilities? Understand the total cost of purchasing and maintaining a home before purchasing one.
- How much time have you spent in the neighborhood/community you are buying? Consider renting until you are sure that particular community is an excellent long-term fit for your needs.
- Have you given thought to whether you are running from something or running to something? Especially due to the pandemic, most everyone wants to change; take your time and don't rush into something you may regret.
- Can you make the home purchase without borrowing from other sources for the down payment? If you cannot, you need to step back and reevaluate if you are buying beyond your means.
- Can you buy the house with enough down payment to avoid Primary Mortgage Insurance (PMI)? Primary Mortgage Insurance protects the lender, and the borrower pays for it; it's expensive because it ends up being claimed on so many times.
- After you add up all those costs, are you still able to save for your retirement and children's education? It is essential to make progress towards your long-term financial goals.
- Can you wait a year or two when the home market will most likely cool off? If you can, now may be a time you wait, for folks who overextended themselves will need to sell. When there are more properties on the market, buyers get a better buy.
My sentiment of the real estate market cooling off is not what my realtor friends want to hear. I don't think this real estate fad will stay. If you take the time to do your homework, get your ego in check, wait to buy when you can afford what you are getting into and have enough knowledge to believe it's a good long term buy, you will be able to avoid being house poor. This is not the first time real estate rose in value to some high new levels, and every time in the past, they came down when the interest rates changed and there was more supply than demand. Interest rates have nowhere to go but up.
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Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.
All investing involves risk including loss of principal. No strategy assures success or protects against loss.