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You may have heard the term “house rich, cash poor” before.
Sometimes it’s even just called being house poor.
But what does it mean?
And more importantly, why is becoming house poor so disastrous to your finances?
In this post, I’ll help you understand what being house rich and cash poor means, and will provide some tips on how you can prevent it from happening to you.
Table of Contents
Why Being House Rich Cash Poor Is Financial Suicide
What Is House Rich Cash Poor?
Before we dive into this topic, you need to understand what exactly it means.
Being house poor is when you have a lot of home equity, but little to no liquid assets.
In other words, you may be rich in terms of your home’s value, but you’re poor when it comes to having cash on hand.
For example, you might have real estate that is worth $500,000 but you only have $1,000 in your bank account.
But this isn’t the only way to end up house poor.
If you buy a house that you can barely afford, most of your monthly income will go towards your monthly payments, and very little will be left for your other bills.
This can be a major problem for homeowners because it leaves you vulnerable to financial disaster.
Understanding How You Qualify For A Home Loan
Let’s dive into this idea of your mortgage payments to drive the point home.
To qualify for a mortgage, most underwriters will compare your gross income to your current debt and the monthly payments on your potential new home.
When just looking at housing expenses, they want this debt to income ratio, or DTI to be 28% or less.
Understand housing expenses cover your monthly mortgage payments, both principal and interest, property taxes, homeowners insurance, and homeowners association fees, or HOA fees.
It does not include your monthly utilities, your monthly maintenance costs, or the closing fees you pay on your mortgage.
Then they add in your additional debt, like credit cards, student loans, car payments, etc. into the mix.
They want to make sure your DTI ratio stays under 36% here.
For example, let’s say your gross salary is $50,000.
If you take 28% of this, your monthly payments for your house cannot exceed $1,150 a month.
If you have additional debt, the total of this monthly debt plus your housing costs cannot exceed 36% of your gross income, or $1,500.
Something to understand is if you don’t have any other debt, your home costs could be as high as $1,500 a month and you still are in good shape.
Of course, there are exceptions to this rule.
If your DTI ratio ends up coming in at 38%, the bank won’t deny you the loan.
They will still approve you.
In fact, if you have a solid credit history and score, you could go as high as 50% or $2,090 and still get approved.
This is where financial trouble starts for homeowners.
The Problem With Debt To Income Ratio
Here is the major problem with the way this formula is set up.
It uses your gross income, not your net.
If you take $50,000 and divide it by 12, you have a monthly gross income of $4,167.
But we all know that this isn’t the amount that gets deposited into your checking account.
You are paying income taxes, health insurance premiums, and even contribute to your 401k plan.
If these total 25%, your $50,000 salary is now $37,500.
On a monthly basis, that comes to $3,125.
Let’s assume you have zero debt but are taking out a mortgage that has a monthly payment of $2,090.
After you pay your mortgage, you have $1,035 for monthly living expenses.
Let’s say your other bills are the following:
- Groceries: $300
- Cable: $200
- Cell Phone: $75
- Electric: $200
- Gas and Insurance: $175
These bills alone total $950, leaving you with $85 for any other monthly bills, discretionary spending, and savings.
It doesn’t take a math major to see that cash is going to be tight.
Put another way, you are going to be house poor. Imagine your friend asking you to go on a vacation.
How will you pay for it?
What if you need a new car?
What are you going to do?
The answer is usually credit cards.
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My Experience With Being Cash Poor
I fell into this trap when I bought my first house.
The only debt I had was my monthly student loans.
I was making $40,000 a year and bought a house that had my monthly mortgage payment of $1,450.
This put me just at 45% DTI.
So I thought I was in good shape.
But I really wasn’t.
My monthly net income was $2,200 a month.
Here were my monthly bills:
- Mortgage: $1,200
- Student loan: $200
- Car Insurance: $140
- Gas: $125
- Groceries: $300
- Electric: $100
This came to $2,065.
Do you see the problem?
I was only bringing in $2,200 so after paying my bills, I only had $135 to live on.
I didn’t spend anything on entertainment, cable, or saved anything for my future financial goals.
To try to make it work, I was living on peanut butter and jelly sandwiches, but this wasn’t enough.
I ended up having to get a roommate to help me cover the costs.
Before that, I was going into debt almost every month, which only added to my monthly bills, and making my financial situation even worse.
Other Ways Being House Poor Can Ruin Your Finances
There are additional ways in which being house poor can hurt you financially.
#1. No Retirement Savings
One of the biggest problems with this scenario is that homeowners don’t have anything saved for retirement.
Because most of your earnings is going towards expenses to help you survive today, you can’t afford to put money away in retirement accounts.
Eventually when you are able to, you have to save a lot more to make up for lost time.
#2. No Emergency Fund
Another issue is that you don’t have an emergency fund.
This means that if something unexpected comes up, like a car repair or medical bill, you don’t have the funds to cover it.
You are forced to put the expense on your credit card, which only makes your debt situation worse.
Now you yet another monthly bill.
And chances are you can’t make the full payment, so you carry a balance.
This means you are charged interest, which drives you deeper into debt.
And piling on debt drops your credit score, making it harder to borrow in the future.
And if you are approved for a loan, you will face higher interest rates, causing any debt to be more expensive.
#3. Put Off Life Goals
When you are house poor, it’s also hard to achieve other life goals.
You may have to put off buying a new car or taking that dream vacation because you don’t have the cash saved up.
Friends might plan fun getaways that you can’t go to because you can’t afford it.
You might even have to delay having a child or getting married because of your financial situation.
#4. Stuck With Your Job
Being stuck in your job is a very real issue for homeowners in this situation.
You can’t afford to quit and do what you love because the salary isn’t enough to cover your bills.
So you have to stay with a job you are unhappy with because you can’t afford to do something else.
#5. Emotional Issues
Finally, you will experience emotional issues.
You will feel anger because you feel stuck in life.
You will experience stress, knowing you have to watch every penny and even then, know you might not have enough to cover your bills.
You may feel embarrassment or be jealous of your friends who are better off than you.
Depression is very likely as well.
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You might even go through denial, at which point you spend money even though you don’t have it.
This is the most dangerous part as you can do major financial damage in a short amount of time.
Ways To Avoid This Scenario
Now that you can see how destructive this is, what can you do about it?
Here is a list of options that includes ideas both for new homeowners and those already in financial trouble.
#1. Buy A House You Can Afford
This is by far the most important thing.
Don’t listen to what the banker or your realtor says that you can afford.
Do the math on your own.
Create a monthly budget to see how much money you can put towards a mortgage payment.
The issue I see with the DTI calculation is it uses gross income.
As I said before, you net income is much lower after accounting for taxes, health insurance premiums, 401k contributions, and more.
A better way to this is to take your gross salary and multiply it by either 2 or 2.5.
The answer you get is the maximum loan amount you can comfortably afford.
So if you are making $50,000 then the maximum loan for you is between $100,000 and $125,000.
Understand this is loan amount, not purchase price.
If you are putting 20% down, you add this to the number above.
So the houses you are looking at are selling for between $120,000 and $150,000.
When you use this formula, you guarantee you will be able to pay all of you monthly bills, live life, and save.
Plus you will have more home equity from the start, allowing you to qualify for low interest rates.
#2. Save More For The Down Payment
Some might use the formula above and see there are no homes in their area for that amount of money.
The answer to this is to put more money down.
If you are taking out a $125,000 loan and you put $75,000 down, now you are looking at homes in the $200,000 range.
It will take time to save up this larger lump sum, but it is a simple way to get a bigger house.
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Plus, you will have more than 20% more equity in the property, helping you to avoid private mortgage insurance.
And finally, your interest rate will be lower because you are seen as less risky to default,
#3. Put Off Buying A House
You could also consider putting off buying a house for the time being.
While people debate buying vs. renting all the time, renting isn’t the worst thing.
Especially if it makes financial sense for you.
During this time, you can work on getting promotions so you are earning a larger salary or even travel a little to make sure where you are living now is where you want to buy your primary residence.
#4. Buy A Smaller House
You might be looking at houses you think are an ideal fit for you, but are they really?
If you are single, do you need all the extra room?
Maybe you will be happy in a smaller house that costs less.
Take the time to really consider the things you need in a house and what you would like and then review and revise the list a few times before going to look.
#5. Get Creative
Most people look for the perfect house that they can move right into.
But if you think a little differently, you might be better off.
For example, a good option might be to buy the house that is cheaper because it needs some cosmetic updating to it.
As long as it is livable, you can take your time and slowly update it room by room as you have the funds.
Another option is to buy a duplex.
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Become a homeowner in one half and rent the other half out.
The rent you earn from the other unit will cover a good portion of your monthly mortgage, allowing you to survive financially.
Then you can move and buy a single family home and rent out the half of the duplex you were living in.
Now that entire mortgage is being paid by other people and you are building wealth.
The bottom line is, if you take the time to think creatively, you can come up with a solution that fits your needs.
#6. Pay Off Debt
If you have other debts, it makes sense to pay off as many of these as possible.
This will free up more of your cash to put towards a mortgage or to have each month to live on after you make your mortgage payment.
To make this work best, I recommend the snowball method.
This will allow you to wipe out debts fast, speeding up the process.
And speaking of debt, you might hear people say that mortgage debt is good debt since your house appreciates in value.
While this is true, if you take out too large of a loan, this good debt can actually be bad debt.
#7. Reduce Your Spending
If you are a homeowner and are struggling, the first thing to do is to review your spending.
You need to slash as many non-essentials as possible.
Maybe you have a gym membership.
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Cancel it and use the many free workout videos on YouTube.
If you have a discount grocery store in your area, consider doing more of your shopping there.
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Cut out meat from your meals a few times a week.
While cutting your spending won’t help if you are in major financial trouble, it can help if you are closer to the edge.
#8. Get A Second Job
Another option is to get another job.
The added income could be what you need to make ends meet.
While you could get a traditional part-time job, I suggest looking at the gig economy and other types of work.
This will allow you to find something you enjoy, which makes it more likely you stick with it even after your financial situation improves.
Plus, many times you can earn a lot more from these jobs than a lower-paying job like in retail or the fast food industry.
#9. Get A Roommate
Consider getting a roommate.
It might not sound ideal, but you aren’t in a position to be picky if you are adding to your debt every single month.
This isn’t to say you should bring in anyone as a roommate, but be open to the idea.
All of your monthly utilities will be split and you will have the rent money.
When I did this, it stopped the bleeding and things became much more enjoyable for me.
And a few years later, when he moved out, I was able to afford my house thanks to getting a couple promotions at work.
#10. Sell And Take The Hit
Finally, you might want to consider simply selling your house and moving on.
This can be tough, especially if you have to bring some money to the table.
But over the long term, this could be the ideal scenario.
Yes it is hurtful financially and embarrassing, but the good news is you can learn from this lesson.
And you can protect your future.
Look at it this way.
Say you sell for a loss and have to rent an apartment or worse, move back in with Mom and Dad.
As painful as this sounds, you now can balance your budget and start getting back on your feet financially.
The time to do this will be a lot shorter than if you stay in your house.
And if you are going into credit card debt each month to stay, imagine yourself 15 years from now.
Chances are you will still be carrying that debt with you.
Regardless if you are married or not, or have kids or not, it will impact you.
You might be stuck in a job you hate. You might not be able to afford a new house.
Maybe you can’t provide for your family like you would like.
And you most likely won’t be saving for retirement.
Your finances will most likely be even worse.
Don’t make this huge mistake.
Cut your losses, sell, and start to rebuild your finances and your life.
At the end of the day, while homeownership is a goal for many, being house rich cash poor is something you want to avoid at all costs.
Use the tips I provided to make sure you never find yourself in this situation if you are not yet a homeowner.
And if you are in this situation, use the tips to help you survive.
You can get through this.
It’s not easy, but it is possible.
Just remember that you are not alone.
Many homeowners have been in this situation and come out on the other side stronger and smarter.
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I have over 15 years experience in the financial services industry and 20 years investing in the stock market. I have both my undergrad and graduate degrees in Finance, and am FINRA Series 65 licensed and have a Certificate in Financial Planning.
Visit my About Me page to learn more about me and why I am your trusted personal finance expert.