Variable Expenses Can Kill Homeownership Budgets
After buying your house this summer, sitting in the cooler autumn air on your deck enjoying your morning coffee was just what you had in mind. Trees and the outdoor air satisfy so much better than the apartment balcony.
Thankfully, the cooler air also brings relief from the higher-than-imagined water bill and electric bills. Hard to believe the bills tallied three times what you paid at your last apartment. But, hot weather leads to watering the yards more often, not to mention running the A/C with a house twice the size of the apartment.
This all sets you back an additional $250 per month that you hadn’t planned on spending, but it’s only for 3 months of bills. Plus, you bought the largest house you could afford based on the payments.
An unsettling feeling begins to creep into your stomach since you’ll see the higher bills for maybe six months next year. But, you can’t sit around all day. Your spouse wants those new flowers planted this weekend. Another $400 on the credit card.
A few weeks later, the mail brings the current property tax bill. It looks higher than you thought, but the loan required escrowing money every month with the lender, so let them handle it.
A month after that, a mortgage statement arrives from your lender. You already set up auto-pay and have paperless billing, so no need for the lender to send a letter. However, in reading the mortgage statement, your payments on January 1 go up by $500 per month! The escrow analysis they included shows your property tax bill of $8000 for this year topped the $5000 you remember from the closing documentation. The lender paid the $8000 and wants you to pay it back over a 12-month period. But $3,000 only requires $250/month. Why $500 per month? The lender also wants to collect an extra $250 per month for the required 12 months to cover the higher property taxes when they come due again next year (regulations governing escrows, property taxes, and insurance, as well as repayment of shortages in escrow accounts, fall under Regulation Z in 12 CFR 1026.37(c)).
That unsettling feeling you had a few months ago now morphs into regret since you have to cut out $500 per month from your already stretched budget, not to mention the higher utility bills.
Where Did You Go Wrong in the Budget?
This scenario plays out more frequently than one might think. Homeowners frequently forget to include increases in utility costs in their budget. Perhaps the homebuyer didn’t even give much thought to an increase in these costs. In a high electricity cost state like the northeast or California (two or three times that of most other states), a simple oversight can cost the homeowner dearly.
For water use, many utilities have a tiered rate structure. So, each additional gallon over a certain threshold costs more than each gallon under that threshold. When buying a house, many buyers simply create their budget expecting current utility expenses not to change, and they learn the hard way about fluctuations in utility bills.
Property taxes also change annually. Many factors influence the tax bill, which may change from one homeowner to the next. Each sale may trigger a “re-appraisal,” meaning the taxing authority uses the sale price to increase the value on which it bases its property taxes.
Additionally, “exemptions” (effectively discounts on taxes) are usually available for homestead (primary residence), seniors (over a certain age, usually 65), and sometimes veterans or those meeting certain disability statuses. Realtors and sellers may show the taxes paid in a prior year to a potential buyer, but that may not accurately portray the taxes due after a new owner buys the house.
Lender Budgets Compared to Real Expense Budgets
Thousands of lenders and websites have “mortgage affordability calculators.” However, these calculators only look at the budget the lender will use for evaluating the homebuyer’s ability to repay a mortgage. Ability To Repay (ATR) means something very specific to each lender. The ATR factors a payment of principal and interest based on the loan amount and interest rate. Additionally, the lender uses an estimate of taxes and property insurance.
The lender’s responsibility for accuracy only extends to a correct calculation of principal and interest calculation. The lender does not have a responsibility to the buyer for correctly estimating property tax and insurance estimates. This responsibility for finding out property taxes and insurance falls only to the buyer. Other costs in the lender’s calculations include Mortgage Insurance if the homebuyer puts less than 20% down on the loan, HOA dues, flood insurance, and in limited cases, other assessments against the property. The lender uses a percentage of the buyer’s gross income as a benchmark to the ATR.
The Lender Budget can vary dramatically from the actual budget a borrower needs in order to live day to day. What’s not in the Lender Budget? It omits income taxes, social security taxes, Medicare taxes, medical insurance, medical costs/deductibles/copays, life insurance premiums, utilities, food, gas, car insurance, car repairs, 401(k) contributions, phones/internet/streaming, home maintenance, and myriad other day-to-day expenses.
In multiple recent studies, up to two-thirds of recent homebuyers had regrets about home buying, and most regrets aligned with unexpected costs, buying too large of a house, being at the edge of qualifying, or too much strain on the overall budget. In fact, according to Fannie Mae’s research, 64% of future homebuyers said that they expect mortgage lenders to educate them. Mortgage lenders do not advise buyers about budgeting beyond the ATR level. So, nearly two-thirds of future homebuyers are starting out in the wrong direction with insufficient financial information.
Develop Your Unique Real Expense Budget
Each potential homebuyer needs to develop a unique real expenses budget based on his or her own circumstances. This involves developing priorities and an understanding of how these priorities affect the household budget as well as the future budget as a homeowner. But, developing such a “real expense budget” requires the homebuyer to do some research prior to making an offer on a home.
Almost every county, city, or town has a website to provide information on tax rates, homeowner exemptions, and property assessments. Property insurance is a bit trickier since it is specific to each property. However, a homebuyer should talk with an insurance agent about different kinds of insurance prior to making an offer. Many buyers end up with the wrong insurance and only find out when they need to file a claim that the insurance company won’t pay the expected amount on.
Overall, first-time homebuyers are usually under budget and misunderstand home maintenance and repair costs. Maintenance expenses will always occur for small things like paint, landscaping, nails, tools, and hundreds of other expenses. Homeowners need to budget money for such costs. Still, major repairs or replacements can cause the most damage to homeowner budgets.
An air conditioning system can easily set back a homeowner by $10,000. Plus, if the homeowner puts this on a credit card or a line of credit with the service provider at 20% interest, the budget and payments will jump up quickly. While homebuyers should not forego an inspection (ever), they should understand that an air conditioning system may work the day of an inspection and fail the day after closing.
In general, major expenses can suck up 1% to 1.5% of the price of the house each year. Some experts recommend planning for up to 4% of the purchase price for upkeep, maintenance, and repairs on older homes. These costs may come in lumps and bumps. A homebuyer already teetering on the financial edge, living paycheck-to-paycheck, will regret not budgeting earlier.
A recent study by Salary Finance found that many homeowners already live on that edge, no matter their income level. Don’t become part of the one-third of homeowners living paycheck-to-paycheck in their beautiful new home. Budget right, and buy without regret.
