So you’re about to move to a new city. Or maybe your lease is up at your current place and you’re looking for a change.
Anyone who’s ever had to go to the trouble of finding a new place to live knows that the apartment search process can be extremely stressful. There’s an overwhelming number of factors that have to overlap in a certain time frame to find just the right apartment. Do you want a one- or two-bedroom apartment? Then there’s the neighborhood, the amenities, and the pet policy to think about. And in more competitive markets, you often need to make decisions fast to snap up a gem.
But before you even start thinking about any “nice-to-haves” for your next place, you need to hone in on a monthly rent payment that is right for your personal financial situation. Not only will determining your budget beforehand set you up for financial success later, it will also narrow down the number of properties you’ll need to explore during your search — saving you both time and money.
But how do you know how much rent you can afford?
The two primary factors that you should consider are your monthly income and your monthly expenses. Using these as inputs, you can calculate a rent payment that is right for your unique situation.
Rethink the 30% Rule: The Financial Picture Has Changed
If you’ve read anything about personal finance, you’ve likely heard of the 30% rule. This rule states that you should spend no more than 30% of your gross income on housing. So if you earn $3,000 per month before taxes, the rule says you should spend no more than $1,000 on rent.
Although this rule has more or less been accepted as a piece of personal finance gospel, it might be time to reconsider. The 30% rule has its roots in the Housing and Urban Development Act of 1969, which capped tenant rent in public housing projects at 25%. This was later raised to a 30% cap with the Omnibus Budget Reconciliation Act of 1981.
What many may not realize is that this percentage was set as the absolute maximum for the nation’s poorest families. In other words, 30% was an extremely high boundary that those in need of public housing should not exceed in order to be able to afford the bare necessities.
Many lenders and landlords adopted the 30% rule as a good rule of thumb and still use it today. Lenders often require your debt-to-income ratio to be below 30% to approve you for a loan, while many landlords will not accept your application if your gross monthly income is not at least three times the monthly rent.
However, while lenders and landlords might adhere to this rule, it doesn’t mean that it is in your best interest. After all, the 30% rule was created in an entirely different financial universe. In the 1960s, college graduates weren’t burdened with astronomically expensive student loans and the average Joe was eligible for the now-mythical pension plans.
When considering how much you should pay in rent, you should instead take into account your full financial picture. That includes your current emergency savings, your level of debt, and whether you’re on track for retirement. To make this calculation, consider instead the 50/30/20 rule.
The 50/30/20 Rule for a Holistic Financial Picture
Unlike the 30% rule, which doesn’t take into account other financial factors that make your situation unique, the 50/30/20 rule can provide a useful guideline for how you should be holistically allocating your income every month.
The 50/30/20 rule is a budgeting tool that breaks down your monthly expenses into three groups, assigning a specified percentage of your monthly take-home pay (after taxes) to each category. These are:
- 50%: Needs. This includes your rent and other living expenses like groceries, utility bills, car expenses or public transportation, and minimum monthly debt payments (e.g. credit card debt, student loans, or car payments).
- 30%: Wants. This is the fun category that includes things like travel, eating out, and other types of entertainment.
- 20%: Savings (or Financial Goals). This category includes money you put toward your emergency fund, retirement accounts, investments, and any acceleration payments you put toward debt above your minimums each month.
Now, let’s take a look at some specific figures. Let’s say you have a gross monthly income of $4,000 and pay a tax rate of 22%. That means your take-home each month would be $3,120 and you would have $1,560 each month for things like monthly rent, groceries, utilities, minimum debt payments, and transportation.
If you were to follow the 50/30/20 rule, your budget might look something like this:
Once we account for these other recurring monthly expenses, you’re left with $960 that you can comfortably put toward housing, which is 31% of your take-home income.
The inputs in the calculations above are, admittedly, rather optimistic when it comes to debt and living expenses, and likely won’t accurately reflect your personal financial situation. Allocating 50% of your income toward recurring monthly costs should only be used as a rule of thumb, and needs to be adjusted to fit your current circumstances.For instance, if you have high-interest debt, need to bulk up your emergency fund for unexpected expenses or aren’t on track to reach your desired retirement savings, you should consider putting more than 20% of your income toward the financial goals category. Additionally, if you’re just starting out in an expensive city, your necessities may come out to be more than 50%. The major takeaway is if you have to pull from one bucket, pull from the discretionary expenses or “wants” category.
Finding how much money you should spend in each of the 50/30/20 budget categories will depend on many factors, such as your annual salary, where you live, your debt load, and current spending habits. However, you can use this calculator to determine right budget for your situation and start growing your net worth for the future.
To use the calculator:
- Open the spreadsheet
- Click “File”
- Click “Make a copy…”
- Fill in the pink boxes on the spreadsheet with your data, and the calculator will do the rest of the work for you!
Find Ways to Reduce Your Rent
If you’ve run the numbers, you may find that it would be extremely difficult for you to find an apartment within your budget. After all, in expensive rental markets such as New York City or San Francisco, finding affordable housing at any income level can be difficult.
Maybe despite your best efforts, your rent still eats up a disproportionate amount of your monthly income. It can be extremely frustrating, but you’re not alone.
In fact, a 2018 Harvard University study found that, between 1990 and 2016, the national median rent has been rising 20% faster than inflation. The same study also found that, in 2016, 38.1 million households — that’s 47% of all renting households — were spending more than 30% of their household income on housing, while 11 million households were spending over 50% of their total income on rent.
If you find yourself in a similar situation, you might want to explore ways to reduce your rent or other recurring monthly expenses in order to reach your other financial goals. There are various ways to decrease your monthly rent charges. You could:
- Find a roommate
- Move in with a family member
- Downsize your space
- Move to a less expensive area
If none of those are possible for your particular situation, you can always find ways to reduce other costs. Maybe you could bike or take public transportation to work, eliminating monthly car expenses. Or perhaps you might try to eat out less, or forego that gym membership you never seem to get around to using. No matter what you decide, there are plenty of creative ways to save money that could get you closer to a healthy 50/30/20 budget allocation.
Relax in Your New Place, Knowing You Made the Right Choice
Knowing how much rent you can afford every month is crucial to setting yourself up for a secure financial future. By keeping your housing expenses in check, you can free up money for other goals that will make your life richer in experience and in wealth.
Maybe you’d like to save for a down payment on a house, or travel the world. With a little bit of forethought and some number crunching, you can put your feet up and relax in your next apartment knowing you’ve taken great strides toward achieving your financial goals.