A major aspect of building wealth is simply being diligent about your expenses.
And rent is a major overhead expense for many Americans. About 36.6 percent Americans rent rather than own the place they live in (that’s the highest figure since 1965), and many of those renters are spending too much.
But how much is “too much?” There are several opinions. We’ll explore below some useful ways to calculate your optimal rent-to-income ratio. First, though, here’s a quick visual reference that you can keep handy:
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Formula No. 1 — 30% of Your Monthly Income
This is the formula that the Joint Center for Housing Studies of Harvard University uses most in its analyses of the American housing supply, and it’s the one we use in the infographic above. (It’s also the math your landlord is likely to use to determine whether he or she thinks you can make the rent.)
The math is easy: Take your monthly pre-tax income, and multiply by 30 percent. So, if you make $50,000 per year, that breaks down to $4,167 per month. Thirty percent of that monthly income figure is $1,250, which is the max rent this formula suggests you can afford.
Hint: If you’re starting with an annual income figure, you can just divide that number by 40 to get the same result:
(50,000 / 12) x 0.3 = 1,250
50,000 / 40 = 1,250
This simpler formula scales to accommodate roommates and partners, as well. “If you and your roommate are looking at an apartment that costs $3,000 per month, the landlord would require a combined income of $3,000 × 40, which equals $120,000,” Mariela Quintana at Naked Apartments writes. “To determine how much rent you (and your potential roommates) can afford, simply divide your combined annual incomes by 40.”
Formula No. 2 — The 50/30/20 Model
Quicken recommends this calculation for people living in cities where rents are particularly high. This model calls for:
- 50 percent of your monthly income to go to overhead expenses (rent, bills and insurance),
- 30 percent to go to discretionary spending, and
- 20 percent to go to debts and savings.
The key here is making room for tradeoffs. If you want to live in Brooklyn, for example, you might not need a car. No car means no car insurance, and so transportation becomes less of an overhead cost.
“The 50/20/30 rule can help twentysomethings start sorting out the complicated world of personal finance,” the Mint.com team writes. “Make an effort to get into this habit, and budgeting will be a far simpler task throughout your life. Sure, you can make adjustments with a tweak here and a nudge there, but by staying close to the core concept of this budgeting system, you’re guaranteed to gain financial ground, rather than lose it.”
How Prescriptive Are Rent-to-Income Calculations?
In many cases, a formula provides a good rule of thumb, but it’s not perfectly prescriptive. As HuffPost writer Alexander C. Kaufman says, putting a 30 percent cap on rent (or mortgage) payments seems unnecessarily frugal for someone earning $500,000 per year.
Ultimately, your rent costs will be a function of where you live, your lifestyle and your savings plans.
Images by: David Hellmann