How much rent or house payment can you afford and still live comfortably?

rentingYou must decide between a couple of places, the cost is only a couple of hundred different a month and one place is so much bigger. Should you spend the extra money for the extra space or not? Will you end up putting yourself into a bind down the road if you face unexpected bills? This is often a question faced by many people who are moving out on their own for their first time and or buying their first home. Banks have guidelines as to how much money they would be willing to lend you based upon your current earning power and other criteria, but as we’ve seen that hasn’t worked out so well for the banks and many borrowers. Along the same lines, some renters are required to pass certain criteria to qualify for renting. Predatory lending and variable ARMs on loans were partly the culprit for the current economic crisis, and banks sacrificed short term profits at the expense of long term sustainability, but we’ll save that talk for another day, it will get us nowhere fast.

So how much money should you spend when looking at housing or when deciding which apartment to rent? Below, I will make it easier for you to devise a smart plan for yourself, so you don’t have to count on someone else telling you a magical debt to income ratio you should abide by.

Step 1: Determine how much money you take home after taxes.

This should be a fairly easy task, how much money are you taking home, not grossing? Look at your paycheck and sum all paychecks for the month. Take into account how often you’re paid. Some months there will be four weeks, while others there will be five. If you’re paid monthly, you know you will be paid the same amount. Some folks are paid bi-monthly, and it works out the same way. However, those folks paid weekly may have fluctuations in their monthly take home pay and should take this into consideration.

Step 2: Calculate your monthly expenditures that are not housing or utility related.

Calculate how much money you will spend on a monthly basis on items such as food, gas to get to work, bus or taxi fare, clothes, car insurance, renters insurance, cell phone, and so on. If you’ve got credit card bills and other bills include these here too. Don’t forget about spending money for entertainment either.

Step 3: Calculate your monthly expenditure related to housing and utilities for each of your new options.

While non housing goods are probably going to be fairly stable (with the exception of gasoline), you must calculate how much your utilities will cost for each option. Ask the current owners or renters or landlords what the bills for each place run each month. A place twice as big will likely cost twice to heat and cool, while water maybe constant. Don’t forget about cable, internet, trash, and other utilities like your phone.

Step 4: Determine how much money you should be saving and investing.

You must pay yourself and save and invest in your future. If you’re not calculating saving at least 10% of your pay (and have an emergency fund equal to living expenses for how long it will take you to find a job if you lose yours – you’re setting yourself up for failure otherwise) you are saying you don’t care about your own future, and want to work for the rest of your life for money, instead of having money work for you.

Step 5: Combine the numbers and see which option makes cents.

Here’s an example of a 22 year old kid (we’ll call him Freddy) that makes $30,000 per year, paid weekly, and he’s planning on moving out of his parents house at the end of December.

Freddy’s After Tax Pay = $462 per week. ($30,000 less 20% taxes = $24,000 per year after tax, you can calculate this by taking $30,000 times .8 or $30,000 times .2 = $6,000, then take $30,000 less $6,000 = $24,000) ($24,000 divided by 52 weeks = $462 per week).

This means in January, a five week month, Freddy takes home about $2310. While in February, Freddy only takes in $1848. It’s important to take this into account as you can see it’s a big difference.

Let’s look at those two months, Jan. and Feb.:

Freddy is considering renting two different places Option A and Option B, one Option A costs $750 per month, and Option B costs $1000 but is twice the size. He really wants the second place but is not sure he can afford it or not.

For Jan. and Feb Freddy estimates the two different options to determine what makes sense:

Option A Option B
Take Home Pay for Jan 2310 2310
Rent -750 -1000
Gas, Food, Entertainment, Credit Cards -400 -400
Savings (@ 10% of take home pay) -230 -230
Utilities -500 -600
End of the month money Leftover 430 80
Option A Option B
Take Home Pay for Feb 1848 1848
Rent -750 -1000
Gas, Food, Entertainment, Credit Cards -400 -400
Savings (@ 10% of take home pay) -185 -185
Utilities -400 -650
End of the month money Leftover 113 -387

Clearly, you can see why it’s important to do this type of analysis. You don’t know what is the best option until you crunch the numbers. It wouldn’t make sense to take on more than you can afford in option B. Freddy wouldn’t be able to cover his bills more less savings goals in February with option B, even though he could it in Jan.

In general, it doesn’t make sense to back yourself into having 0 dollars left over at month end. What if your car breaks down and or you have to buy a gift for someone. I would suggest you leave an additional cushion of around 10% to cover unexpected costs that may come up. After you’ve gotten comfortable doing this for a year or two and you’re certain you can manage your finances properly you can take more risk in leaving a cushion, perhaps by then you will have built a couple of emergency funds to cover potential unemployment and or other financial emergencies like car repairs.

Hope this helps!

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4 Comment

  1. […] See the rest here: How much rent or house payment can you afford and still live … […]

  2. Ken says:

    I like the step by step layout of your post. Great info. We didn’t take into account the savings step when we bought our home…we are not saving what we would like…instead we are looking at extra part time income. Good job.

  3. Thanks for the comment Ken. Yes, savings is critical to getting out of the rat race.

  4. Letting says:

    “Most people in england gain housing benefit and many councils have a rent guarantee program where they give money to rent a place. And a deposit to boot”

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