Housing is typically the single largest expense in any household budget. You may have heard of the 30% rule when it comes to renting a house or apartment. This rule is that your rent payments should not exceed 30% of your gross income. While it has become a popular metric that is often repeated, many financial planners consider this rule to be long outdated. Back in the late 1960’s, when the 30% rule came into existence, most Americans didn’t have mountains of student loan debt and the 401(k) hadn’t yet been invented. In fact, it was still fairly common for employees to stay with one employer their entire career. They could expect a decent pension upon retirement. Then there are red hot housing markets on the other end of the spectrum, like San Francisco.
When the rule was first created, the math behind it was quite simple. If you made $40,000 a year, then you would calculate $40,000 x .30 to get your total maximum rent for the year. Based on this calculation, $12,000 is the maximum a person would be able to spend on rent. This equates to $1,000 a month. This does not include student loans, car payments, credit card bills, medical payments, food, and other expenses.
Should you use the 30% rule when shopping for a place to rent? Financial planners say that there is no one-size-fits-all answer. It’s best to look at your spending and calculate a budget that works for you. In addition, most landlords will look to see that you make three times the monthly rent to approve you for housing. This means if the rent is $1,000, the landlord expects you to make at least $3,000 a month. In general, 30 percent is probably too high with the rate of current salaries and living standard costs in the US. However, you can still use this number to calculate a baseline and then look at your budget to see what rental payment allows you to pay your bills and save money.
Understand Your Budget First
Before you can understand how much you are able to spend on your rent, you need to get a handle on your disposable income first. Create a budget based on a 90 day look at your income and expenditures. It’s a good amount of time to understand what an annualized run rate will look like. Rather than focus on spending 30% of your gross income, you should be looking at spending no more than 30% of your remaining disposable income. This will allow you to allocate enough money towards a 401(k), savings account, vacation fund, and an emergency fund when life gets in the way.
Tackle Debt before Rent
When younger people graduate from college, they are often anxious to move out on their own. They also are prone to having some form of debt, be it credit cards or student loans (or both). Consider the options available to keep rent payments to a minimum. Likewise, if you plan on skipping renting altogether, make sure you purchase a home you can comfortably afford. There is no shame in living at home with your parents. Ideally, living with them would be rent free, or much less than you would pay living on your own. You can also consider living with a friend or roommate. Having a roommate provides you the ability to not only split the rent, but the utilities, food, and share in the chores around the home. Every dollar you save can be used to reduce debt. The earlier you pay down your debt, the less time the interest has to accrue on the loans. Timing can be everything when you are younger. After all, you have all your earning years in front of you still.