There are a lot of good reasons to choose to rent over buying a home. Whether you are looking to move again in the next few years or are not financially ready to purchase a home, renting is a great option. With less expensive initial costs and flexibility to move sooner than you would after buying a home, renting is superior if those are your circumstances.
Just as the question of “how much house can I afford” often crosses into a homebuyer’s mind, the question of “how much should I spend on rent” occurs. When tackling this question, there is always the option to create your budget, but there are two schools of thought on the subject. These two ideas come from the perspective of how much you should take of your gross monthly income or your take-home income toward your rent payments. Looking at both of these will give you an idea of the prevailing wisdom for renting, and you can then judge how much you should earn based on that. Neither is perfect, but they are good guides to follow.
The 30% rule
This rule dictates that you should not spend more than 30% of your gross monthly income on rent. It is a straightforward rule, but it only focuses on rent and excludes considerations for other necessities that will affect your monthly budgeting. In effect, all you need to do to determine how much you should spend on rent is to multiply your gross monthly income by 30%.
For example, if your gross monthly income is $4,000, your rent should not exceed $1,200. This monthly rent cost leaves the remaining 70% or $2,800 for other necessities, like utilities and food, plus wants and savings. This tactic is also consistent with the practices of some landlords and property owners that require a renter to be able to pay for three months of rent with one month worth of pay. So, if you are looking to rent an apartment or home that costs $1,200, the minimum you should earn as your gross monthly income is $4,000, or $48,000 annually.
The main issue with the 30% rule is that it does not consider any other aspects other than rent. While you would satisfy the rule with $4000 as your gross monthly income, you may also have student loans or other debt. Based on your take-home income, you need to balance the rent, which is 30% of what you make before taxes, with all the other payments that you may have. All of these payments make a significant difference in the remaining money you have after rent, which can make things tight.
Consider that you will be losing about 20-25% in taxes before you are paid, making that $4,000 closer to $3,000. So, after rent, you have $1800 to split between utilities, food, debt, student loans, a car payment, gas, insurance, health care, and any wants you may have, like entertainment.
It also fails to consider where you may need or want to live may be expensive compared to other areas, which will adjust the percentage. While it has its flaws, it is a guideline to consider when comparing your earnings versus rent payments.
The 50/30/20 budget
Another straightforward rule, the 50/30/20 budget evaluates the full range of your spending and plans how it should be allocated. The breakdown is:
- 50% on needs like:
- Rent
- Utilities
- Food
- Minimum debt payments
- Health care
- 30% on wants like:
- Entertainment
- Clothes
- Games
- 20% for savings and additional debt payments
The purpose of this budget is to break down all of the things you will spend money on in a month and allocate them to a designated category. As opposed to the 30% rule, this is based on your take-home pay, which aims to give you more realistic figures to work with. The 50/30/20 rule also allows you to look for additional savings in the needs and wants categories, depending on what your financial goals are.
Let’s look at our example from earlier, and we can see how that fits into this budget. With $3,000 after taxes, the breakdown is:
- $1500 on needs
- $900 on wants
- $600 for savings
If you know how much you need to pay for everything else that is not rent, you can estimate what you can afford. For example, let us say that all of your other needs will add up to $1,000 between utilities, food, debt, student loans, a car payment, gas, insurance, and health care. This leaves you with $500 to use for rent, which will be challenging to work with in many places in America.
We can see from the breakdown above that our $1,200 rent calculation from the first rule is not feasible without pulling money from either spending on wants or savings. With all of the pieces that make up the needs section, we will need to earn more, have cheaper accommodations, or spend less on wants. The vital part of this budget is that it allows you to see all the costs in front of you and then allocate them as you see fit. While useful, you do not have to stick to it blindly. If you find that you do not spend $900 on things that you want, you can allocate more to your needs. It is important to note that you should not pull from your savings, as that is for the future.
Final thoughts
The best plan is one that works for you. These guides can get you most of the way there to understanding how to allocate your monthly pay. The goal, from there, is to be realistic in how much you will spend past your needs and leave room to save.
