Following one simple rule could help you avoid taking on too much house. Read on to learn more. [[{“value”:”
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In 2020 and 2021, mortgage lenders lowered their rates in the wake of the economic crisis the pandemic spurred. Not shockingly, home buyer demand soared as a result, driving home prices upward.
Back then, it was common for buyers to make offers well above sellers’ asking prices for the opportunity to lock in a mortgage at under or around 3%. And that’s precisely what friends of mine did when they attempted to upsize their home in 2021.
Since these friends of mine earn good money, they figured they could afford a more expensive property, especially at a time when mortgage rates were so low. And while they did snag a great rate on their mortgage, they paid a few hundred thousand dollars over asking to buy a home when they did. Between that and other factors, over the past few years, they’ve become house poor — despite having a combined $300,000 income.
Where things went wrong
My friends live in an area where homes are generally expensive. A starter home in their town could cost $500,000, for instance.
That was the type of home they had when they decided to upgrade. They initially had a budget of $1.2 million but fell in love with a $1.3 million house. To outbid other buyers, they wound up paying $1.5 million.
Now I don’t know what down payment my friends made on their home. But assuming it was just 20%, that left them to borrow $1.2 million. At 3% for a 30-year fixed loan, that’s a monthly payment of $5,059 for principal and interest.
And that doesn’t include property taxes. In New Jersey, where my friends live, they’re high in general. For their home, they’re paying over $2,000 per month in taxes.
All told, by my friends’ estimates, between their mortgage, property taxes, insurance, and maintenance (their new pool costs way more than anticipated), they’re spending around $8,000 a month to own their home. But that’s problematic.
Breaking it down
When we break my friends’ $300,000 income down into a monthly income, that’s $25,000. And that’s on a pre-tax basis.
Meanwhile, as a general rule, it’s important to keep housing costs to 30% of your take-home (meaning post-tax) pay or less. But by virtue of spending $8,000 a month on their home, they’re spending 32% of their pre-tax income, which means they’re exceeding the 30% rule by quite a bit. And it’s definitely caught up with them.
Since moving to their home, my friends have had to cut back on other spending to cover their costs. They haven’t taken a vacation in three years, and money is tight — and it really shouldn’t have to be when you earn $300,000 a year.
Don’t fall into the same trap
If your household income is fairly high, you may feel confident moving forward with an expensive home purchase. But before you do, crunch the numbers and make sure your total housing costs won’t exceed 30% of your take-home pay. Going beyond that point could leave you feeling squeezed financially.
When I spoke to my friends about their financial situation for this story, they admitted that their logic was flawed. See, they actually expected to have to cut back on other expenses, like vacations, to be able to afford their house, but they figured it would be worth it. As my friend said, “I’d rather give up a week of vacation each year and enjoy 52 weeks in a comfortable house.”
At the same time, though, my friends acknowledge that they went overboard because they’re not just giving up vacations — they’re stressed about paying their grocery bills. And now, despite earning $300,000, they’re looking at picking up side hustles to keep up with their housing expenses.
Worse yet, there’s really no financial relief in sight. Their home is only going to get more expensive to maintain over time, not less, as it ages. And because property taxes tend to rise frequently around here, theirs could increase at any time.
Plus, it’s not as if refinancing their mortgage is likely to be an option anytime soon, since they signed their loan at a point when rates may be the lowest buyers today see in their lifetime. So all told, unless they manage to snag huge raises at their main jobs, owning their home is going to be an ongoing struggle. Be very careful if you’re looking to buy so you don’t wind up in the same boat.
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