How To Avoid Becoming House Rich & Cash Poor

by Millie Kay G. on 2011-09-255

Back before the nation’s housing market ended up going to the dogs, it was acceptable — and even smart(!) — to pursue a home with as little money as possible. Indeed, many families felt that the risks they were taking by chasing a dream seemed worth the future rewards of the real estate bubble. Now that some time has passed and our expectations of the housing market have changed, I’d like to discuss what it means to be “house rich and cash poor” as it pertains to the average homeowner.

This phrase is often used to describe people who have acquired so large a house payment that they can’t meet basic needs in other budget categories. Maybe you have neighbors who moved in last year but who can’t afford to furnish most of their rooms. Or perhaps you know someone who subsists solely on canned soup and hot dogs because all their money is being sucked into the black hole called their monthly mortgage. According to the U.S. Census Bureau, the average monthly housing cost for homeowners was $1,505 in 2009, with 38% of homeowners spending more than 30% of their income on housing. For most families, their primary residence is still going to be their largest asset, ahead of retirement accounts, stocks and bonds.

Is Your House Considered An Asset?

Actually, there’s a certain amount of debate as to whether a home should be considered an asset or not. If you look at a typical Net Worth worksheet, you’ll see that the house or primary residence is listed on the Assets side, while your mortgage and home equity loan are on the Debts (or Liabilities) side. The debate tends to arise when you end up selling your home for less than what it’s worth. In this situation, your home becomes a liability since you lost money. Also, if you don’t turn the proceeds from the sale into the purchase of a cheaper home, you face the possibility of wiping out your profits by taking on a bigger mortgage. It may be wise not to view your house as an asset if you expect to move within a few years or if you’re going to pursue a bigger mortgage for your next residence.

Should You Consider Your House As An Investment?

The debate over considering a house as an asset also ties into another argument, namely: should a house be thought of as an investment at all? Before 2008, it seemed like houses were going to appreciate in value forever. Many homeowners thought that they’d make their fortunes as their properties became more valuable. However, those types of high returns aren’t coming back soon, if ever. And if you add up property taxes, home improvements and inflation, you’re probably making less than you think. Remember that the true cost of home ownership extends beyond your mortgage payments. Despite the stock market’s turmoil, most long-term stock investors are expected to make more profit than homeowners.

Still, the other side of the argument is worth hearing. If you own your own home, you’re investing in your own bottom line, not a landlord’s. And if you live in a crowded housing market, you’re likely to face rent increases that can add up to a substantial amount over 20 or 30 years. Also, despite the housing bubble, home values don’t typically have the volatility of the stock market. Personally, I’ll think of my home as a shelter first and an investment later, if I ever foresee selling the place.

Tips To Avoid Becoming House Rich & Cash Poor

Let’s go over a few tips to avoid becoming a financially overextended homeowner:

#1 Don’t go overboard. Develop and stick to a housing budget.

When the housing market suffers a significant slide or when mortgage rates drop, you may be tempted to go house shopping. But how can you know if you’re in the best position to buy? After all, you don’t want to be the one who ends up house rich and cash poor. For starters, you can scrutinize your income and expenses. If your paycheck won’t allow for an increase to your housing allowance, then you might need to make some adjustments. Can you afford a down payment of 20 percent? You’ll probably need to account for closing fees, home inspections and other expenses as well.

Next, you can talk to your banker or mortgage broker to figure out how much of a mortgage you can pre-qualify for. This number may end up being less than you expect. Determine your home buying budget with these steps in order to stay within the limits of what you can afford. Don’t be afraid to take a few more months to save up for your house and the expenses associated with it.

#2 Seek & pursue financial balance.

What if you’re already in the situation of being house rich and cash poor? If you’ve had your mortgage for several years, you may benefit from refinancing, particularly when mortgage rates are down.

Tip: One resource is Making Home Affordable, the federal government’s program for helping homeowners who are facing foreclosure or who are having problems meeting their mortgage payments. Another is Fannie Mae’s Know Your Options site.

Be aware of your liquidity situation and be proactive about raising your cash levels.

#3 Don’t treat your house like a bank account.

It’s also important to keep in mind that even if you’re doing well as a homeowner, you shouldn’t make the mistake of thinking that you can always dip into your equity to use your house like you do a bank account. A HELOC, home equity loan or second mortgage shouldn’t be taken lightly. This was what got a lot of people into trouble during the golden age of real estate in the 00s. There are folks who are property heavy and have very little liquidity, who mistakenly assume that they are in good shape. But are they really? They feel more than comfortable about overleveraging, while using their properties as collateral. Many overconfident individuals make high risk moves, feeling that they’ve got a solid enough safety net in their real estate holdings. Many people also think of their homes as not just their largest asset, but as their ONLY asset. I don’t see this as good risk management, but surprisingly, it’s a position that many homeowners are happy enough to be in.

Home ownership is a desirable goal because families need shelter and a place to thrive. However, you should think twice if you’re taking on more debt than your budget can handle when you’re buying a new or bigger home. Being house rich and cash poor can impose limits that prevent you from taking on better investment opportunities or that distract you from paying off other debts. Buy smarter when it comes to real estate and don’t neglect to build up your cash reserves. The key to remaining solvent and stress-free over the long term is to have a balanced financial set up.

Created October 6, 2006. Updated September 25, 2011. Copyright © 2011 The Digerati Life. All Rights Reserved.

{ 5 comments… read them below or add one }

The Biz of Life September 26, 2011 at 10:10 am

I’d caution people to overemphasize liquidity so they can weather the tough times without losing the house. Even given the historically low mortgage interest rates, we need to be aware that the risk of losing a job can be relatively high these days.

SB @ One Cent At A Time September 26, 2011 at 4:57 pm

Very few among us ever do a calculation before buying a home. In my blog, I encourage people to do basic math to check on buy vs rent. As per my own calculation in my area, renting is better (while saving for home buying). This is the calculation, if any one is interested.

Silicon Valley Blogger September 26, 2011 at 6:32 pm

@Biz of Life,
Thanks for pointing out that this is the time to handle our financial matters more conservatively. Some people I know are expressing great excitement about the low loan rates and lower home prices, but I would be very cautious about making huge financial transactions if you’re low on liquidity.

@SB, Thanks for the information. I’ve shared some of these calculations here before as well. It’s imperative that a prospective home buyer goes through these exercises before making that big step and huge decision.

krantcents September 26, 2011 at 7:25 pm

I only take on a mortgage payment that is roughly near my weekly salary equivalent. It is really comfortable that way.

Mr. Frugal October 1, 2011 at 1:11 am

I really hope the heyday of real estate speculation is over. The notion of owning a home as an easy and surefire way to build wealth through equity was so heavily popularized that people stopped thinking through the process. Mrs. Frugal and I learned a lot about this the hard way. We bit off more than we could chew for a while and came to understood the value of balance between the value of owning a dream home and living a great life which encompasses all of the things we love to do.

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