How Much Rental Payment Can I Afford?

2020-01-27

How Much Rental Payment Can I Afford?

How Much Rental Payment Can I Afford?

Chances are your rental payment is your single largest monthly expense. As rental rates are only getting more expensive, it’s important to calculate how much rent you can afford to spend each and every time you move. With such a big chunk of your monthly earnings being spent on renting your home, how can you be sure you’re not overspending and that you’ll still be able to pay your other bills without living like a pauper?

The 30% Rule Is Outdated

For decades landlords have been using the 30% Rule to determine if a tenant’s income meets the threshold for being able to make timely rental payments every month. The rule has become so engrained as a standard metric, that it’s even taught in business schools. According to this rule, your rent payment should not exceed 30% of your monthly gross income. If your salary is $4000 a month, then $1200 is the maximum you should be spending on rent. 

The origin of this “rule” dates back to 1969 as part of the HUD Act, which initially set the limit for public housing rent at 25%. Later, in 1981, this guideline was increased to 30% with the Omnibus Budget Reconciliation Act. These figures were used to set limits for contributions made by low-income families living in public housing so they would have enough left over for bare necessities. The rule was conceived and applied to households earning as little as 50% of the country’s median income. This “increase” to 30%, however, not only was meant to max out what a household spent on rental payments but also to decrease the government’s contribution to subsidized housing.

Though it’s still used as a quick estimate, it’s an average, and furthermore, it hasn’t been updated to reflect modern expenses like cell phones, internet, and cable charges.

Calculating How Much Rental Payment You Can Afford

Even if your landlord is still using the 30% Rule for approving applications, you should run your own numbers and calculate your rent ceiling. Using a formula like, “If my rent is X, then I need to make at least X” is too simple as it doesn’t do a good job of taking into account all of your actual bills. To reach a more reasonable figure, you’ll want to plug in all other factors affecting your financial situation into the formula.

Start by creating an actual Monthly Budget Worksheet like this one, supplied by the government. Go through all the categories and be as honest and accurate as possible. For expenses that vary month-to-month, like utility bills, try to take a 6-12 month average.

Create a Budget

The best thing you can do for yourself is to set up a monthly budget—and stick to it. Sitting down and calculating all money coming in versus all of your expenses will give you an accurate snapshot of your financial situation. When spending money indiscriminately, you have no idea how quickly those daily cappuccinos from the coffee shop on the way to work, the lunch with co-workers, or those end of the week bar bills add up. Having a visual will help you to know exactly how much money you need to cover expenses, and much you are actually spending or saving. 

Sample budget assuming our $4000 monthly salary:

  • gas – $80
  • electricity – $100
  • cable TV – $120
  • wi-fi – $70 
  • auto insurance – $150
  • gasoline – $80
  • health insurance – $125
  • cell phone – $95
  • food/groceries – $250
  • car payment – $300
  • credit card bill – $50
  • restaurants/entertainment – $300
  • gym membership – $15
  • online streaming service – $10
  • savings – $200
  • emergency fund – $100
  • miscellaneous – $50

Total Monthly Spending = $2095

Now it’s important to remember, the $4000 salary in our example is a gross figure, so taxes will need to be accounted for. So if we agree that the 30% Rule is too lenient, let’s use a more conservative “25% Rule” instead. Let’s see how the numbers work out:

$4000 salary x 25% Rule = $1000 maximum rent

$4000 salary – $800 taxes @ 20% = $3200 net income

$3200 net income – $2095 monthly spending = $1105

As you can see by working through our monthly budget, we have $1105 left over to spend on rent, which is reasonably close to the $1000 the 25% Rule recommends. If you consider incidental spending or a slight variance in your personal expenses, the 25% Rule gets you pretty close to where you need to be.

It’s safe to assume that most renters don’t sit down and work out a budget, hence, they genuinely don’t have a good idea where all their money goes, let alone how much rent they can afford. Most renters just wing it, figuring if the landlord approves their application for a lease, then they must make enough money to make their rental payment. However, a landlord’s main objective is to determine if you can make rent every month.

They run a credit report to verify income and your credit history, but they aren’t overly concerned with whether or not you’re able to meet your other financial obligations. It’s your responsibility to understand your financial limits, which will help keep you from scrambling at the end of every month when the rent comes due.  

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