The Risks of Buying a House That’s More Than You Can Afford

If you’ve lived with your parents and roommates, home ownership is a major step towards a greater feeling of independence. If you're moving in with a significant other, that, too, is a major milestone. Even if you're upgrading from your current home, the joy and peace of mind the perfect property brings are invaluable.

Buying a home can be one of the most exciting phases of your life.

But don’t let your dreams outpace reality. Overextending yourself on buying a house that’s more than you can afford can be disastrous. Credit score collapse, foreclosure, and more can combine to make the dream a nightmare. 

Before committing to an expensive home purchase, run the numbers: does your budget align with your expected home value? Can you afford high monthly mortgage payments and upkeep costs? By shopping for a home after due diligence, you set yourself up for long-term financial stability.

Understanding Home Affordability

"Affordability" when buying a house is very different and more complex than typical budgeting concerns. Affordability in the context of a new TV, computer, or even car is pretty straightforward – do you have the cash to buy them outright while maintaining your emergency savings and budget, or do you need to modify your spending slightly to accommodate a one-time purchase? In most of these cases, affordability is a binary and clear-cut concept. 

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Home affordability and mortgage affordability, though, are leagues apart from budgeting out a new phone. A range of factors beyond mere price impact how you budget for buying a house. Some variables include:

Prevailing Interest Rates and Peripheral Costs

Higher interest rates mean higher mortgage rates – which ultimately means a higher monthly payment in the short term and more interest paid over the loan's lifetime. Running two scenarios through a mortgage loan calculator can be revealing. 

We’ll look at two rates:  4.9% in 2019, right before the pandemic brought rates to all-time lows, and today’s 7.76%. We’ll also assume a home value of $431,000 (today’s median sale price), 20% down, and a standard fixed 30-year mortgage.        

2019: $1,337.65 per month.

Today: $2,472.57 monthly. 

That’s an 85% jump in monthly cost. Note, too, that this is simply principal and interest payments on the mortgage. HOA fees, insurance, and taxes can easily add another $1,000 to your monthly payment, depending on location. And, if you can't afford a 20% down payment on a conventional loan, you're likely on the hook for mortgage insurance (PMI), which tacks on an additional 1.5% of the loan’s value every year ($6,465 annually in this case, or another $538 each month!). 

Home Quality and Repair Scope

If you’re buying a dream home with some nagging repairs and renovations, be prepared to budget even more. In 2022, homeowners spent $6,000 on basic costs and repairs. Most experts agree that allocating 1% of the home value to annual upkeep is the bare minimum to budget for home maintenance. Your home might need substantive repairs, like foundation and roof work, or you're on a journey to make it your own through extensive renovation. In that case, you must factor that into your affordability considerations. 

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The Risks of Overspending on a House 

Today, the median household annual income is $71,737. For single adults living alone, that stat is $45,927 per year. If we use the previous example’s principal and interest cost, you’re looking at a minimum $29,670 annual expense on housing. That’s 40% of the median household income before insurance, HOA dues, PMI, and taxes. Becoming overburdened with a home you can't afford can happen quickly – and presents dire consequences. 

Financial Consequences of Buying an Expensive House

In the short term, the consequences are clear. By buying more home than you can afford, you're risking budget bloat that can wreak havoc on your personal finances. Today, consumer credit card debt is at an all-time high, and many Americans are falling behind on those payments. Tack on an additional few thousand dollars per month, and you may have to cut your budget elsewhere to afford the home.

In worst-case scenarios, you'll risk destroying your emergency savings and being unprepared for one of life's contingencies. And you can forget about renovations or making your dream home a reality – if you can barely afford to put food on the table, you likely can't devote much cash to home projects. Likewise, you risk missing the boat on annual upkeep. That can tank your home's value and leads to longer-term risks of buying more home than you can afford. 

If your home value declines, whether through insufficient upkeep or broad market trends, you can quickly become underwater on the loan. This means you owe more than the home is worth or what you could get from a quick sale. This closes off a whole slew of opportunities, including home equity loans. At the same time, your home insurance covers the house up to a set value. If you owe more than it's worth, and there's a flood or fire that destroys the property, you could end up with thousands of dollars difference you'll have to pay.

You also risk missing mortgage payments, which, of course, puts you at immediate risk of foreclosure and losing the home. Even if you work out terms with the lender to stay in the home, your credit will take a massive hit and affect you for years to come. 

How to Determine Your Home-Buying Budget

1. The first step to determining your budget for buying a house is diligent market research. Use the above example as a template. What are homes in your desired selling for, in general? What is the sales price for homes you’re specifically looking for, i.e., number of bedrooms, outdoor features like pools, and kitchen style?
2. Once you’ve projected a rough purchase price and know a solid down payment number you can easily offer, run your numbers through a mortgage calculator. This will generate a baseline number to budget against monthly. But remember, the costs don't stop there – use your local tax office to estimate annual tax expenses and shop around for home insurance offers.
3. Finally, add 1% of the purchase price, divided by 12, to your monthly budget allocation to address basic maintenance and repair. If the home needs some work or you have big renovation dreams, a better figure to plan against is 5%. 

When you're buying a new home, emergencies and other contingencies pop up often. You'll need cash to close, new furniture, and more. Plan for  future, one-time financial expenses by budgeting a little extra beyond your emergency savings account to keep a healthy cash cushion.

Alternatives to Buying an Expensive Home

Of course, you don’t have to choose between overspending and not buying a home at all. Many alternatives to buying an expensive house exist, even if they require a little more time, patience, and effort – but they’ll pay off in the long run.

Plan for Slow Renovation Scheduling

If you can find a home that’s outdated or needs some basic cosmetic repairs, you can often get them much more cheaply than their updated counterparts. As long as the structural aspects of the home are fine and it's safe, buying an older home in need of some work can be a great way to get your dream home cheaply. Once you're in the home, you can accurately forecast renovation costs and budget for them in the future. If you're handy, you can save money by working on the house during downtime and weekends rather than paying pricy contractors. Remember to be patient – you probably won't be able to completely overhaul a home quickly on a budget. 

Broaden Your Horizons

If you're willing to commute to work or be a bit off the beaten path, expanding your search radius can reveal hidden bargains. Rural and suburban homes often sell more cheaply than their metropolitan counterparts, and widening your search radius beyond big cities can help you find homes close to your ideal location much more cheaply. 

Likewise, you can broaden your horizons by shrinking expectations. If you're a two-person family, do you really need a full three-bedroom/three-bath layout? If you struggle to reach your ideal home on a budget, lowering expectations slightly and going for a smaller property can bring your buy under budget. 

Tips for First-Time Homebuyers 

Of course, if you’re set on a specific location or property type and can’t afford it, waiting is the best course of action rather than jumping into an agreement you can’t afford. Patience pays dividends, and waiting for the stars to align is in your best interest. In the meantime, here’s how to set yourself up for success when you are ready to buy a home:

Build Up Your Savings

Building a budget is the best way to prepare for future home ownership. A good rule of thumb to follow is the 50/30/20 Rule:

1. 50% of your income is dedicated to needs (bills, groceries, etc). 
2. 30% go towards wants like travel, shopping, and entertainment. 
3. 20% strictly for savings.

If you're set on buying a home, carefully weigh whether today's wants are worth 30% of your earnings and dedicate a greater allocation to savings.

Pay Down Debt

Your mortgage lender will look carefully at your debt-to-income ratio during underwriting. Paying down debt today will make the lending process much easier in the future. At the same time, it’ll boost your credit score and might mean better terms on an eventual mortgage. If you’re carrying a high debt load, explore one of the many options to tackle the problem quickly.

The Bottom Line

Buying a home is exciting, but buying more than you can afford is a real risk. Step back, carefully consider all options, and be realistic about the risk of overspending on a house. Patience and due diligence will pay off in the long run. Remember – a little pain today, like cutting certain discretionary expenses from your budget, can make the difference between living in your dream home (or not).

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