You are looking to rent an apartment, but wondering how much you should pay in rent?
Below are three rules that most financial experts suggest as a guide to renting an apartment:
Rule #1: Spend a maximum of 30% of your annual income on rent.
Rule #2: Your annual income should be at least 40 times your monthly rent.
Rule #3 – 50-30-20 Rule. This rule is a little more complicated as it provides approximate percentages to different ‘expense categories’, but we explain in further detail below.
Let’s go over each rule.
Rule #1 – The 30% Rule:
If your annual income is $40,000 per year, multiply $40,000 x 30% (40,000 x .30). The result is $12,000. This number is the amount of rent you can afford to spend each year. If you divide by 12, the result is $1,000. $1,000 is the approximate amount of rent you can afford per month with an annual income of $40,000. Keep in mind, some experts believe you should allocate 30% to your after-tax rather than pre-tax income.
Rule #2 – 40x the Monthly Rent Rule:
This rule is helpful if you already know the rent. Assume your rent is $1,000 every month. Multiply the monthly rent by 40 and the result will be $40,000 per year of income. Because you generate the same result in both equations, both strategies are an efficient and accurate way to calculate what price range your rent should be in.
If one of the rules shows that you cannot afford the apartment you’d hoped to rent but you were reasonably close to the price range (say within 10%), it could be worthwhile to make use of another helpful rule: the 50/30/20 guideline.
Rule #3 – 50/30/20 Rule:
This will require you to create a household budget of your expenses into three of the following categories:
- Fixed monthly expenses: includes rent, utilities, transportation, and insurance (health and auto)
- Day to Day expenses/wants: includes entertainment, dining out, shopping, and other miscellaneous things
- Financial expenses/goals: includes debt repayment, emergency funds, and savings
This rule of thumb says:
50% of your after-tax income should be allocated to “Fixed Expenses”
30% of your after-tax income should be allocated to “Day to Day Expenses/Wants”
20% of your after-tax income should be allocated to “Financial Expenses and Goals”
For example, if your net income (income after taxes) was $30,000 per year, you would have the following available in each of the above categories:
- $15,000 per year (50%) for Fixed Expenses ($30,000 x 0.50)
- $9,000 per year (30%) for Day to Day expenses ($30,000 x 0.30)
- $6,000 per year (20%) for Financial Expenses and Goals ($30,000 x 0.20)
If after performing this budget exercise you determine that your “Fixed Expenses” would allow you to pay more rent and still fall below the recommended 50% (of total income) threshold, or if you can reasonably adjust your discretionary spending (the Day to Day expenses) lowering the amount spent below 30% (of total income), you could then reallocate the remaining excess to “Fixed Expenses” and rent.
Be careful and honest with yourself when reallocating or lowering expenses between categories.
These suggestions are broad and meant to encourage healthy spending and management habits to increase financial stability. With any luck, after reading this post, you’ll walk into your apartment search feeling affirmed, well-informed and ready to rent. Remember these are just rules of thumb. Everyone’s situation and goals are different.