Please make sure you’re sitting down when you read this: A staggering 10.9 million American renters are spending more than half of their income on rent, according to the Joint Center for Housing Studies at Harvard University.
What’s the cause of this trend? Part of it may be that the cost of rent is rising faster than incomes, as shared by that same report from the JCHS.
So how can you combat this? Proper budgeting helps. However, in the right situation, your best bet for avoiding the rent problem may be to avoid renting altogether.
Budgeting With The 30% Rule
If you’ve never created a personal budget before, you might struggle to figure out how much of your income should go toward rent. A great place to start is the 30% rule, which instructs renters to cap their rent spending at 30% of their gross monthly income.
Many financial experts endorse the 30% rule because it’s generally not recommended to spend more than 25% – 30% of your income on housing expenses. It puts the rest of your financial life at risk.
For instance, if you make $4,000 a month, 25% – 30% of your monthly income shakes out to $1,000 – $1,200. By not going over $1,200 a month on rent, you’ll still have at least $2,800 a month left over for your other expenses and savings after you pay your rent.
Or if you make $8,000 a month, 25% – 30% of your monthly income is $2,500 – $3,000. After you pay rent, you would still have $5,000 – $5,500 a month for your other expenses.
The Disadvantages Of The 30% Rule
As previously mentioned, the 30% rule can be your best friend at the start of your budget research, but it’s not the most exact measurement for how much rent you actually can afford. Based on inflation alone, the 30% rule of thumb is somewhat outdated, and it doesn’t match the actual cost of rent relative to how much people make today.
Another major disadvantage of the 30% rule is that it doesn’t consider your debt, additional expenses or overall cost of living. Paying off student loans or credit card debt can severely limit the amount of cash you have to spend on living costs, which means that 30% would put you over your budget. Furthermore, renters who live in cities with high rent may find it impossible to get their housing below 30% of their before-tax income.
The 30% rule also falls short for high earners as they determine how much they should be spending and saving overall. A person making a $200,000 salary would need to spend $5,000 a month on their rent to meet the 30% rule. And while there certainly are apartments that go for that price, high earners are often better suited putting that money elsewhere.
Using The 50/30/20 Rule
As a popular alternative to the 30% rule, the 50/30/20 rule of budgeting can help you paint a more accurate picture of how much you should actually spend on your rent. Simply put, the rule states that you should dedicate no more than 50% of your take-home income on any needs or expenses you’re required to pay. After that, you can set aside 30% of your cash as disposable income and another 20% toward savings and debt repayment.
Within that 50% division, you’ll have room to accommodate your rent and see how it stacks up against all your other bills. At the same time, you’ll ensure you have money to put toward your savings (and yourself).
Although the 50/30/20 rule provides a more comprehensive look at the relationship between your rent and the rest of your finances, you might still find that it doesn’t work with your long-term financial goals. If, for example, you’re aggressively tackling your debts, there’s a good chance you’ll want to devote more than 20% of your income toward that borrowed money.
Creating Your Own Personalized Budget
If an existing budgeting tool doesn’t fit your needs, you’ll need to make your own budget to determine what percentage of your income should go to rent. The most basic personal budgets include a tally of your monthly expenses against your monthly income, which helps you spend less money than you bring in.
Here are a few quick steps to get you started with your budget:
- Calculate your total monthly income after taxes.
- List your regular expenses. To find how much you pay for costs that are charged annually, divide your total bill by 12.
- Estimate the amount you spend on variable costs month-over-month.
- Determine your long-term financial goals – such as saving up for home or starting an investment portfolio – and estimate the amount you should dedicate each month to reach these objectives.
- Set aside money for nonessential purchases and an emergency fund.
With all your expenses and income lined up, you can take some time to determine how much you can afford to spend on renting or buying a house and go from there.
If you feel you’re spending too much, it may be time to downsize, move to a different city nearby or look for other expenses in your rent payment where you can save.
Spotting Places To Save On Rent
If you’re not able to manage your current rent in conjunction with your other expenses, then your next plan of action is to reduce your overall living expenses as much as possible. As an example, renters with a spare bedroom can split their bills with the help of a roommate, so long as they discuss the arrangement with their landlords.
You should also look for opportunities to cut down on your renters insurance. Some providers offer bundled coverage, which can help with affordability on all of your insurance-related expenses.
If your lease ends soon, it may be worth renegotiating your rent, especially if you have a good relationship with your landlord or if other apartments in your neighborhood are lower in price.
Rent Or Buy
Once you have a number in mind for how much you can spend on housing, it’s time to figure out whether you should rent or buy.
Both renting and buying have some key advantages, so which one is right for you? Let’s take a look at both options.
Renting can be good for a few reasons.
Renting an apartment may be a good first step for many people. When you’re first starting out on your own, you may only need a small place, and a decent apartment could be just what you need.
This also gives you the opportunity to build up credit and to create a history of making utility and rent payments so you can get financing for a house down the line. Most mortgage lenders look at your rent payment history to show that you have made consistent payments in the past.
Renting also gives you flexibility. If you find yourself moving around a lot, being able to get out of the lease after a year without having to put the property up for sale may appeal to you.
Finally, sometimes certain amenities are included when you have an apartment. Depending on the apartment, your utilities, internet and cable might be included in the rent.
As compelling as the case for renting a place may be, there are a lot of good reasons to buy. Every market is different, but chances are, it’s more affordable than you think.
The biggest reason to take the leap and purchase your own home is for the investment. When you give your money to a landlord, you get nothing back out of the investments except a place to stay.
By contrast, when you buy a house, you gain home equity with every payment you make. This equity is very much like a traditional investment in that it can be translated into cash.
How Does Equity Work?
Once you’ve built up equity for a while, you can refinance to take cash out and use it for other purposes, such as updating the kitchen or paying off your credit card debt.
You also may build value quicker in the current market, as home values have been on the rise for a while now. The higher your home value goes, the more money you can make when you sell.
Not only is buying an investment, but it may also be more cost-effective than renting. If you’re able to secure a low-interest mortgage, you may be able to own a home by paying as much as or even less than you’re paying for monthly rent.
There’s also something appealing about having a place to call your own. You can make updates and really make the space your sanctuary. Buying a home also gives you a chance to settle in and get involved in your community, because you won’t be moving when your lease is up.
Understanding Down Payments
While there are certain advantages to a higher down payment, you shouldn’t let the fact that you don’t have 20% to put down keep you from getting a house. There are a variety of options if you’re looking at putting less down. With a conventional loan, you could put down as little as 3% with standard programs. If you’re going with an FHA loan, the minimum is 3.5%.
If that still seems like a lot to pay at closing, Quicken Loans® has an exclusive option for well-qualified clients. You can purchase a home with as little as 3% down. This means you can purchase a $150,000 home with a down payment as small as $4,500.
There are a few restrictions, such as having a minimum FICO® Score of 680 and the requirement that you must be purchasing the home as your primary property.
The Bottom Line: Your Rent Percentage Of Income May Vary
Budgeting rules of thumb are a great place to start when it comes to figuring just how much you can afford on rent, but understanding the best housing option for you shouldn’t stop there. In most cases, a bona fide, personalized budget is the best strategy to ensure that you have all your bases covered when it comes time to pay your bills.
And if your current rent is outside of your means, you do still have other options – such as finding creative ways to save or considering a more affordable home instead.
If you’re ready to kick renting to the curb, get your mortgage process started. And if you have any questions, don’t hesitate to let us know in the comments.