Instead of assigning an arbitrary dollar amount to the monthly rental payments you think you can make, you can perform a few simple calculations to determine a more realistic estimate of your ability to pay. Putting your best financial foot forward includes developing a budget that keeps you on track with your expenses and moves you toward your personal goals. Economists and other financial professionals recommend designating a percentage of your income toward rent payments while considering other monthly expenses and leaving a little wiggle room for savings.
Gross Income vs. Net Income
If you base your rental payment percentage on your gross income, you may cut yourself short before the end of each month rolls around. After your employer (or you, if you're self-employed) deducts taxes and other withholding payments from your gross income, your net pay is the amount you have available for your recurring monthly bills and periodic living expenses. A quick glance at your pay stubs reveals your net pay, also called take-home pay, which is what you can use as a baseline for calculating income-based rental payments.
The 30-Percent Rental Rule
Since the late 1960s, the rule of thumb for calculating rent payments is that tenants should pay no more than 30 percent of their incomes for their rental expenses. But this across-the-board rule doesn't translate fairly to all households. Many variables muddy the water, such as the number of wage earners per household and their combined incomes, as well as the number of children per household and the amount of debt each household brings to the table. For example, if you're a single adult with no children and no debt, you may easily be able to earmark 30 percent of your net pay toward your rental payments. But if you're the sole wage earner with a low income responsible for the financial needs of running a household and caring for numerous dependents, or if you're single and saddled with debt, your ability to pay 30 percent of your income for rent may impose an inordinately high financial burden.
The 50-30-20 Budget
According to the U.S. Department of Housing & Urban Development (HUD), the current economy may beg a rethinking of the 30-percent rule in favor of a budget that more accurately reflects varied economic situations. In a 50-30-20 budgeting plan, 50 percent of your income is designated for living expenses and necessities, including rental payments, while 30 percent is allocated for discretionary spending. 20 percent is earmarked for achieving your financial goals such as debt-reduction, savings and investments. In this budget structure, all expenses related to rent are included in the 50 percent living expense allotment.
Fine-Tune Your Budget
To custom-tailor your 50-30-20 budget and calculate an income-based rental payment amount, divide your monthly take-home pay in half to calculate the 50 percent income amount you'll use for living expenses. Subtract your estimated recurring monthly bill payments, such as utilities and other living expenses, and deduct the grand total from your 50 percent take-home pay amount. The balance that's left gives you a fair snapshot of what you can realistically pay for monthly rent, which is often closer to 20 or 25 percent than the outdated 30 percent standard.
Victoria Lee Blackstone was formerly with Freddie Mac’s mortgage acquisition department, where she funded multi-million-dollar loan pools for primary lending institutions, worked on a mortgage fraud task force and wrote the convertible ARM section of the company’s policies and procedures manual. Currently, Blackstone is a professional writer with expertise in the fields of mortgage, finance, budgeting and tax. She is the author of more than 2,000 published works for newspapers, magazines, online publications and individual clients.