There is no iron law dictating how much you should spend on rent. Many advocate the 30% rule, which advises you spend no more than 30% of your pre-tax income on rent. It’s a pretty good rule of thumb, although there are circumstances where you might spend substantially more or less than 30% of your income on rent.
The best way to determine how much you can afford to spend on rent is by analyzing your overall financial picture and creating a budget that serves your unique situation. In this article, we’ll look at some common budgeting guidelines, identify where they fall short, and discuss how to create a housing budget that works for you.
Common Budgeting Rules
When it comes to figuring out how much you should pay for rent, a few particular budgeting guidelines are often referenced. Depending on your financial situation, these rules may or may not work for you. Since these guidelines are so popular and often referenced by landlords and lenders, it’s worth familiarizing yourself with them, if only to reject them.
Let’s break them down.
The 30% Rule
The 30% rule is a well-known personal finance guideline that suggests that you allocate no more than 30% of your pre-tax income to housing. It has long been used as a rule of thumb, but it has received criticism for being outdated in recent years.
A recent report from the Bureau of Labor Statistics reveals that the majority of Americans spend over 30% of their income on housing, which could indicate that the 30% rule is now unrealistic for many people.
Frustratingly, many landlords still use this rule of thumb and may disqualify you as a rental applicant if you can’t demonstrate that you earn 70% more than the unit price.
The 43% Rule
The 43% rule refers to your debt-to-income ratio. The idea is that your debt should never make up more than 43% of your total income. This metric is used by many lenders to determine creditworthiness when deciding whether someone would be able to pay back the money they intend to borrow.
It’s a handy rule of thumb for you to consider when deciding how much rent you can pay. It may help you hone in on a price range you’re comfortable with. Because this metric considers your overall financial situation, it may be more realistic to use than the 30% rule. However, if you’re already carrying a high ratio of debt, you may need to exceed 43% to put a roof over your head.
The 50/30/20 Rule
The 50/30/20 rule recommends that you put 50% of your after-tax income towards “needs,” meaning housing and bills, use 30% for “wants,” such as entertainment and shopping, and put the remaining 20% into savings.
This budgeting method does account for the big picture of your finances in that it suggests how you portion them. However, if you’re working within a tight budget or have large debt payments, such as a student loan, you may need to put more than 50% of your income toward “needs.”
The trouble with rules
While the budgeting rules covered above offer useful guidelines, they fail to take into account the nuances of your financial situation. The rules start to fall apart if you are earning a small income, living in a city with a high cost of living, or are someone with substantial debt payments to make each month.
These rules also fail to account for individuals earning a substantial income or living with a partner. Just because you are easily able to dedicate 30% of your income toward rent doesn’t mean that it makes sense to do so. Additionally, if you split living expenses with a significant other, you may not need to spend anywhere close to 50% or even 30% of your income on housing.
Create your own set of guidelines
Since each person has a unique financial situation, the best way to decide how much you can afford to spend on rent is by developing your own set of rules tailored to your income, debt, and financial goals.
Start by outlining a budget
In order to determine how much you can comfortably afford to spend on housing, you need to look at your finances overall and create a monthly budget.
Once you know where your money is going each month, you’ll be able to see how much you have left to use for rent. Don’t forget to account for the money you spend each month on bills and debt payments, as well as the money you want to put toward financial goals, your vacation fund, or any other expense you foresee on the horizon.
Account for your long term goals
When it comes to creating a rental budget, it’s essential to consider your long term financial goals. This way, you can ensure that you’re still on track to achieve them.
If you’re aggressively saving for a downpayment on a home, you need to be sure your other expenses are low enough for you to continue doing that. Work out how much money you need to set aside each month to meet your financial goals.
Plan for financial shifts
Another element to consider when budgeting for your rental is how your finances may change in the future.
If you’re just a few months away from paying off your hefty student or car loan, you may find yourself with more room in your budget in no time.
Additionally, you should account for upcoming expenses. Perhaps you anticipate needing to invest in a new vehicle in the near future, are returning to school and need money for tuition payments, or have another large bill on the horizon. Factor these costs into your financial forecast. Do you need to reduce your rental budget to put additional money aside?
Consider the overall cost of your rental
As you know, there’s more to consider than merely the “sticker price” of your rental. When you move to a new place, your living expenses are prone to change slightly.
Once you have an idea of how much money you have available to put toward rent each month, dig into the additional expenses that might come with (or be eliminated by) your rental. Depending on what is or isn’t included in your new place, your rental budget may need to be adjusted.
For instance, if you could find a place within walking distance of your work, you may be able to cut down on transportation expenses drastically, freeing up some additional cash to put toward rent.
On the flip side, if you’re moving out of a roommate situation into your own place, you may find that you need to budget a lot more for utilities than you ever have before. Internet, water, and heat add up quickly when there’s nobody around to share the costs!
Remember, your situation is unique and you’re the best judge of what you can afford. The budget guidelines covered above serve as jumping-off points to help you determine a ballpark of how much you can afford to spend on rent. However, you should always analyze the big picture.
Depending on what’s included in your rent, and how well a particular neighborhood is suited to your lifestyle, it may make sense to go over or under those 30, 40, or 50% guidelines. In some rental markets, you may have no choice but to spend a more substantial portion of your income on rent than personal finance experts would typically recommend.
Ultimately, the most important thing is to ensure that you can make your rent payments each month and still have enough money remaining to cover the rest of your expenses.