Budgeting properly is key to ensuring your financial future. This is particularly true when thinking about housing. One of the largest expenses that many people need to account for is rent. However, the first thing you should consider when looking for a place is exactly what you can afford. Find out some general recommendations and a few myths to avoid.
What Percentage of Income Should Go to Rent?
When trying to figure out exactly what percentage of your income should to rent, you're sure to find a common piece of personal finance advice: Never go over 30% of your income.
This common financial rule, aptly called the "30% rule," is regularly used to create online rent calculators. Landlords and property companies will even use it to determine if a tenant can afford the housing they're applying for.
However, the 30% rule is problematic. Here are just a few of the reasons why:
- It's old fashioned. This rule was established in a different time. The 30% rule became widely used in 1969, when the government introduced regulations that capped public housing rent at 25% of a tenant's income. This later inflated to 30% in the 1980s. Yet over 40 years later, we still abide by this rule. The problem is that the typical consumer had different financial obligations and stresses than we do today. For example, a typical consumer in 1969 did not have worries like rising healthcare costs and student debt.
- It doesn't apply to high earners. If you have a high income, the 30% rule can actually lead to financially irresponsible decisions. For example, it may not make sense for someone making $250,000 a year to spend $7,500 a month on rent. High earners could easily keep rent costs down and use the remaining money to pay off debts faster, save for retirement, or invest in assets that will accrue in value.
- It ignores the financial context. Everyone's financial situation is different. The 30% rule doesn't take into account that some people may have an extraordinary student loan payment each month or a goal of paying off credit card debt. These factors will influence how much money you should be allocating to your rent.
- It isn't personalized. Just like everyone's financial situation is different, so are everyone's needs. Someone who spends a lot of time at home may want to invest more into their rent than someone who has an active social life and spends a lot of time out and about. Someone with a family might want to look for an apartment with multiple rooms rather than a one bedroom. There is no "one size fits all" solution that accounts for these factors.
So how do you know what percentage of your income should go to rent? The simple answer: It depends.
Instead of following a blanket rule that doesn't take your personal financial situation and needs into account, sit down and create a budget that makes sense for you and your family. While this prospect may seem intimidating, there are a few easy steps you can take to crafting a budget that is tailored to you:
- See what you're currently spending. Use a secure financial tracking tool like Mint or Personal Capital to track your spending. This will allow you to get a full picture of your cash in/cash out and how much money you have to spare for housing. A great bonus: It will also help you identify areas where you can potentially cut back and save.
- Anticipate upcoming changes. Going to pay off your student loan within the next few weeks? Thinking you'll need a new car in the next year? Anticipating any large expenses or soon-to-be-available funds that may be coming your way can help you predict what your financial situation will be in the coming months.
- Look at your emergency fund. Take a look at your emergency fund and ask this question: Could you afford to pay rent for a few months if you were to lose your source of income? While it can be difficult, it's important to have an emergency fund that will help you in times of hardship. Being able to cover unexpected costs or loss of income without digging into your line of credit is essential when determining what kind of rent you can afford.
What is the 50/20/30 Budget Rule?
While it's better to take a personalized approach to determine what percentage of income should go to rent, some may still find a guideline helpful. One budget technique that works for many is the 50/20/30 rule.
This rule attempts to calculate your needs, wants, and savings in a clean way. Here is how you can calculate your budget based on the 50/20/30 rule:
- Step One: Calculate your income after taxes.
- Step Two: Calculate 50% of your after-taxes income. This is the amount that you'll allocate for essentials like rent, utilities, and food.
- Step Three: Calculate 30% of your after-taxes income. This is the amount that you have to spend on wants and other non-essentials, including entertainment, dining, and recreational travel.
- Step Four: The remaining 20% of your after-taxes income should be utilized to pay off debts or placed in savings.
Like any other finance rule, it's important to use it intelligently. Always cross-check your calculations against your personal situation so you can make financial decisions that are right for you.