Lowering Your Housing Costs

Housing is the largest line in most budgets, and the hardest to change, because the big decision (where to live, and whether to rent or own) is made once and then repeats every month for years. That is exactly why it matters: a change here saves money every month without any further effort. This chapter shows how to find your true housing cost, the levers an owner has (refinancing, removing mortgage insurance, appealing the property tax), the levers a renter has, sharing the cost with a tenant, and when moving is worth it.

Know your true housing cost

The rent or the mortgage payment is only part of what a home costs. Add up everything you pay because of where you live.

Owners: principal and interest; property tax; homeowners insurance; private mortgage insurance (PMI) if your down payment was under 20%; association dues; maintenance and repairs; and utilities. Maintenance is the line most people leave out. A common rule of thumb sets aside 1% to 2% of the home's value a year, more for an older house, and the cost comes in lumps (a roof, a water heater) rather than evenly.

Renters: rent; renters insurance; utilities not included in the rent; parking; pet rent and fees; and the cost of moving, spread over the years you expect to stay.

Then compare the total with your gross income. Many lenders use a guideline of about 28% of gross income for housing. It is a lending rule, not a law of personal finance, but a total well above it usually means less room for saving and less slack when something goes wrong. The home affordability calculator builds the full monthly cost of owning, including tax, insurance and PMI, from a price and a rate.

Owners: refinancing, when it pays

When mortgage rates fall well below your current rate, refinancing can lower the payment. It is not free: closing costs commonly run to a few percent of the loan. The question is how long the lower payment takes to repay them.

On a loan of $320,000, the monthly payment at 7.0% is $2,129; at 6.0% it is $1,919, about $210 less. If the refinance costs $6,400 in closing costs, the lower payment repays them after 31 months. Sell or refinance again before then and the refinance lost money. This break-even point is the number to work out before anything else.

Three details change the answer:

• Restarting the clock. Refinancing a loan that has 22 years left into a new 30-year loan lowers the payment partly by stretching it out. You can pay more interest in total even at a lower rate. Compare the total interest left on the old loan with the total on the new one, or choose a shorter term.
• Costs rolled into the loan. A "no-cost" refinance usually means the costs are added to the balance or paid through a higher rate. They are still costs.
• Cash-out refinancing. Borrowing more against the home to pay other bills lowers your monthly total only by turning short-term debt into a 30-year secured debt. It deserves the same scrutiny as any new loan.

If rates have not fallen, the opposite question applies: is extra money better spent paying the mortgage down or invested? The pay off mortgage or invest calculator compares the two for your rate and horizon.

Owners: three calls worth making

Remove PMI. PMI protects the lender, not you. Under the Homeowners Protection Act, a borrower in good standing can ask the lender to cancel it once the balance is scheduled to reach 80% of the home's original value, and it must end automatically at 78%. Extra principal payments get you there sooner. Some lenders will also consider a new appraisal if the home's value has risen, under their own conditions. Loans insured by the FHA follow different rules, so check yours.

Appeal the property tax assessment. Assessments are estimates and can be wrong. Read your assessment notice, check the facts it lists about your home (size, rooms, condition), and compare its value with recent sales of similar homes nearby. Appeals usually have a short deadline after the notice arrives, and the process is often free. If the facts are wrong or comparable homes are assessed lower, an appeal can lower the bill every year after.

Shop the homeowners policy. Insurance is the housing cost that changes most from one company to another for the same coverage. Chapter 4 covers how to compare quotes without cutting protection you need. If your insurance and taxes are paid through an escrow account, check the yearly escrow statement for errors too.

Renters: negotiate the renewal

Rent is more negotiable than many tenants assume, especially for a tenant the landlord would like to keep. A landlord who loses a good tenant usually faces at least one empty month, plus cleaning, repairs, advertising and the risk of a worse tenant.

A cut of $100 a month costs the landlord $1,200 over a year, which at many rents is less than one month of vacancy. That is your negotiating room. To use it:

• Start early, two to three months before the lease ends, while the landlord still has time to plan.
• Bring evidence: three to five listings for comparable units nearby, with their rents.
• Show your value: on-time payments, a well-kept unit, no complaints.
• Offer something: a longer lease, a flexible move-out date, or handling small upkeep.
• Be honest. Do not claim an offer you do not have. If you would genuinely move, say so calmly.

If the landlord will not move on rent, ask about the extras instead: parking, a pet fee, a new appliance, or the renewal increase itself.

Share the cost

Renting part of the home you live in, sometimes called house hacking, turns part of the housing cost into income. It can mean a spare room, a basement unit, an accessory dwelling, or the other half of a duplex you own.

A room rented at $900 a month brings in $10,800 a year before tax and expenses. Before counting on that, weigh the trade-offs:

• Tax. Rent is taxable income. You can deduct the share of the home's expenses that belongs to the rented part, and you report it on your return. IRS Publication 527 sets out the rules. One exception: if you rent out your home for 14 days or fewer in a year, that rent is generally not reported at all.
• Permission. A lease may forbid subletting, and short-term rentals are restricted or licensed in many cities. Renting a unit only to re-list it short-term without the landlord's written consent can breach the lease.
• Your home becomes a business. Screening tenants, landlord-tenant law, insurance that covers renters, and less privacy all come with it.

Owners who renovate a home they live in and later sell it should know the main-home exclusion: if you owned and lived in the home for at least two of the five years before the sale, you can generally exclude up to $250,000 of gain from income, or $500,000 for a married couple filing jointly. Periods when part of the home was rented, and depreciation claimed on it, can reduce the exclusion.

When moving is the answer

Sometimes the biggest saving is a different home: a smaller one, a cheaper neighborhood, or a cheaper region if your work can move with you. Moving has its own costs, including movers, deposits, overlap in rent, and for owners the cost of selling and buying, which commonly runs to several percent of the price. A move pays when the monthly saving, times the years you expect to stay, clearly exceeds those costs.

A cheaper region also changes more than rent: state income tax, car costs, and how far you are from family and work all move with you. The state income tax comparison shows the tax side, and the geographic arbitrage calculator shows what lower living costs do to a long-term savings target.