According to a recent report by Pew Research, more Americans are renting their place of residence than at any point in the past half century. In fact, in 2016, almost 36% of households rented their home. If you’re one of these Americans, you may find that rent is your most costly monthly expense.
While that may be the case, there is one great thing about renting: flexibility. Unlike a mortgage payment where you’re tied to a certain piece of real estate or a loan payment for decades, you do have some power over how much you pay in rent.
If you’re hoping to reduce your monthly payment by moving or want to determine if what you’re currently paying is within your budget, your number one priority should be determining how much rent you can afford.
But how do you know if you’re paying too much or too little? There are several rules of thumb that can help you determine what percentage of your income should go to rent. Let’s walk you through the factors that you should consider to figure out how much you should be spending on rent based on your personal financial situation.
First, How Much Do You Make?
Before you can even begin to make an estimate of how much rent you can afford, you first need to know how much money you have to work with. While your annual salary might sound good on paper, that’s your gross annual income, not your net monthly income.
For instance, someone making $50,000 a year might really only take home:
- $50,000 taxable income – 22% tax rate = $39,000 annual net income
When divided by 12, we arrive at $3,250 as the amount you have available to work with for your monthly budget. Keep this calculation in mind, as it is how you will determine the dollar amount from which you can deduct your monthly rent.
Discard the 30% Rule
So, how much of those hard won after-tax dollars should go toward rent?
The first rule of thumb that practically every source of personal finance knowledge will quote is the 30% rule. The rule states, as its moniker would imply, that you should spend no more than 30% of your monthly gross income on housing.
This rule is outdated for several reasons.
The first reason is the decade in which it was decided. The 30% rule finds its roots in U.S. government housing legislation from the 1960s, which capped tenant rent in public housing projects at 25%. That percentage was later increased to 30% in the 1980s to account for rising housing costs. In other words, the 30% rule is almost 40 years old.
The rule’s next offense is its inability to account for a changing financial world. Forty years ago, most companies still provided pension plans to employees — meaning the typical American didn’t have to factor in a retirement savings plan into their overall budget.
Also, 40 years ago, a college education was actually something you could afford. Since 1980, college tuition has experienced an annual increase of nearly 260%, which is more than double the 120% increase in consumer items. Recent graduates are now saddled with unprecedented amounts of student loan debt, which was definitely not a consideration when the 30% rule was conceived.
Consider the 50/30/20 Rule
Since the economy has changed over the past 40 years, it makes sense that the guiding principles for how you should manage your money should change as well. Instead of using the 30% rule as a static guideline for how much you should pay in rent, we recommend you consider the 50/30/20 rule.
This rule breaks down your finances into three categories:
- 50% Needs: This percentage encompasses all of life’s necessities, such as rent, electricity, car insurance, prescription medication, and groceries. You should also include minimum debt payments — whether student loan or credit card payments — as those will severely impact your credit score if you don’t pay on time each month.
- 30% Wants: This is the fun category of non-essential items, and includes things like shopping, dining out, and hobbies — within reason. Basically, the things you enjoy but that are not a necessary for day-to-day survival, such as unlimited texting or your cable bill. You should also include saving for wants like vacations or cars in this category as well.
- 20% Savings: While the wants category allows you to enjoy the present, the savings category will set you up for a more secure future. The 50/30/20 rule suggests you put 20% of your take home pay toward repaying debts (above any necessary minimum payment on a credit card, mortgage, or student loan), an emergency fund, and saving for future long-term financial goals.
Calculate Based on Your Financial Situation
Now that you know how to calculate your net monthly income, and the basics of the 50/30/20 rule, you can determine what percentage of this income should go to rent by using this how much rent can I afford calculator. Since the percentage will vary slightly for every individual based on their financial picture, let’s explore three examples to see how the 50/30/20 rule might shake out for each situation.
Example 1: John, the Recent College Grad
First, let’s see how much John, a recent college grad living in a big city like New York City, might want to pay for rent.
John makes an annual salary of $50,000. After deducting 22% for taxes, that leaves him with a monthly take home pay of $3,250. Like many recent grads, John has student loan debt. His total debt is $46,000, with a minimum monthly debt payment of $500 each month.
Because he lives in the city, John doesn’t own a car, and uses public transportation to get around — his monthly unlimited pass costs $100. And finally, as he only recently set out on his own, John does not have any credit cards, and therefore, no credit card debt.
Given these inputs, we can then determine the following:
Using the 50/30/20 rule, John should spend no more than $775 on his total housing expenses, including rent, utilities, and rental insurance. In New York City, that can be a difficult goal to achieve. However, by living with roommates he could increase his chances of living within his means.
Example 2: Jane, the Mid-Level Professional
Next, let’s see how much monthly rent Jane can afford. Jane has been working in the software development field for about 5 years now, and makes an annual salary of $100,000 in San Francisco. Since she makes more than John, Jane is in a slightly higher tax bracket, and after deducting the 24% she owes to Uncle Sam, her monthly after-tax pay is about $6,000.
Jane was proactive, and has already paid off her student loans. However, she bought a car last year that requires monthly payments of $500. Car insurance costs another $100 each month, while she spends about $200 on gas. Also, Jane also likes to travel and recently racked up a bit of credit card debt, and owes the credit card company a minimum monthly payment of $125.
Given these inputs, 50% of Jane’s net income should be distributed toward her needs according to the following:
Using the 50/30/20 rule, Jane should spend no more than $1,575 on her total housing costs. Given that the average rent in the San Francisco Bay area is $3,500, Jane may also want to consider ways to reduce what she spends on rent in order to stay within a healthy budget, either by living with roommates, moving in with family, or choosing to live in a smaller space. On the other hand, she might be able to find freelance work to supplement her monthly income in order to boost the amount she can spend on rent.
Example 3: Jill and Joe, New Parents
Finally, let’s examine Jill and Joe’s living situation. These two mid-30s professionals live in Houston, Texas and are new parents. Jill works in marketing with an annual salary of $75,000, while Joe is a teacher who brings in about $55,000 each year. While they have healthy salaries for the Houston area, monthly daycare costs of $800 each month as well as Jill’s minimum $500 student loan payment eat up quite a bit of their monthly income.
The couple can afford to spend almost $1,700 on rent each month if they so choose. However, given that the average rent in Houston is about $1,092 a month, the couple could easily find a place to live that cost less than their maximum housing budget and instead put the extra money toward paying off Jill’s debt, saving for a new house, or increasing their retirement egg.
Find the Number That’s Right for You
Whether your situation is closer to that of John, Jane, or our couple in Houston, the great thing about the 50/30/20 rule is that it can adjust to fit your personal financial situation. It’s an excellent guide to help you target a monthly dollar amount for rent, while also keeping you on track for your other financial goals. This 50/30/20 budget template might help you get started.
No matter where you are on your financial journey, budgeting and being aware of your monthly expenses will help you live within your means for a more a secure future. That means you can relax in your place, knowing you’re paying a percentage of your income that’s right for you.