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When renting or buying a house, it’s important to know what percentage of income should go to housing because it’s often your largest monthly expense.
There is no one-size-fits-all rule for every situation, but there are some general rules of thumb to help guide you when making the decision.
However, to truly know what percentage of income should go to housing, you need to examine your current financial picture, what your financial goals are, and what options you have available to you for housing.
Once you have this information, you’ll be able to clearly see what percentage of income you should spend on housing.
Table of Contents
The 30 Percent Rule
The 30 percent rule is an attempt at a simple one-size-fits-all strategy for determining how much you should be spending on rent. It’s helpful in that it gives most people a ballpark number that they can remember, but it falls short in actually achieving the goal of determining what percentage of your income should go to housing if you are renting.
History of the 30% Rule
The United States National Housing Act of 1937 was established during the New Deal era and was the first step in creating federal public housing subsidies. The law stated that recipients were eligible for housing subsidies if their income was less than five or six times the amount of rent, they owed each month.
By 1969, the program was floundering because it was causing rent rates to escalate to the point where they were no longer affordable. It was struggling to meet the mission upon which it was created.
In response, the Brooke Amendment to the 1968 Housing and Urban Development Act established a rent threshold of 25 percent of family income. In other words, a family would be required to pay 25 percent of its income in rent.
The threshold had been raised to 30 percent by 1981 and it continues to be the rent standard for many rental housing programs.
Where the 30 percent Rule Falls Short
This should be obvious, but this rule was created primarily to ensure the housing programs related to the above laws remained solvent.
It is an attempt at a one size fits all method of determining what percentage of your income should be spent on rent. By adopting a rule like this, you are essentially trading the simplicity of the rule for your freedom to decide what works best for you.
The 30 percent rule does not consider personal things like your financial goals, what is important to you, your current debt, or your current income.
To truly determine what percent of income should go to rent, you first need to understand what your current situation is.
43% Mortgage Lending Rule
The 43% mortgage lending rule is less a rule and more an industry norm. For most mortgage lenders, you can have no more than a 43% debt-to-income ratio and still qualify for a home mortgage.
Your debt-to-income ratio is your debts (credit cards, student loans, car loans, etc.) divided by your monthly income.
For example, if you had $2,000 in debts each month and made $5,000 in gross income, you would have a debt-to-income ratio of 40%.
When mortgage lenders calculate your debt-to-income ratio for the 43% threshold, they also take into account your potential mortgage debt.
So, in the previous example, let’s say the debts each month didn’t include your future mortgage payments. When factored in, your debt is now $3,000 each month. Your debt-to-income is now 60% and you no longer qualify for a mortgage at most mortgage lenders.
Where the 43% Mortgage Lending Rule Falls Short
The 43% mortgage lending rule doesn’t take into account your expenses outside of debt.
For instance, let’s say you have five children. What the 43% mortgage lending rule doesn’t take into account is the monthly expenses associated with having five children (more food, clothes, daycare, clothing expenses, etc.).
The 43% mortgage lending rule should be thought of as a ceiling for how much you should have in total debt which will help you determine the upper limit of what percentage of income should go to housing (especially home ownership).
28/36% Rule
There are strict lending rules and then there are some general rules of thumb for healthy financial living. The 28/36% Rule follows in the latter category.
Many financial advisors agree that you shouldn’t spend more than 28 percent of your gross monthly income on housing expenses and no more than 36 percent on total debt (this includes other debt in addition to the mortgage).
28% Rule = monthly housing expenses (rent, mortgage, PMI, taxes, insurance, etc.)/income
36% Rule = all monthly debt/income
Financial Goals
To start, think long and hard about what your financial goals are. Next, write down your short-term and long-term financial goals.
Short-term goals are goals that you plan to complete in less than a year. Some examples of short-term goals include paying off a credit card, paying off a car, saving an emergency fund, etc.
Long-term goals are goals that take longer than a year to complete. Some examples include retirement, getting completely out of debt, funding your child’s college education, starting a business, etc.
Create a Simple, Monthly Household Budget
Once you know what your financial goals are, you need to create a monthly budget.
Start off by tracking your expenses for a month to see where you’re currently spending money.
Mindful Spending – What is Most Important to You?
Next, consider what expenses are most important to you. To determine if an expense if important, consider whether it’s absolutely necessary, whether or not it brings happiness to your life, and whether or not it adheres to your personal values.
Anything that’s not important, consider cutting when you make your budget.
For example, if you spend $200 per month on cable and internet, but don’t really use the cable programming all that much, consider cutting the cable programming and switching over to a cable alternative or cutting cable altogether.
For another example, let’s say you are very health conscious and spend a little more than the average family on food because you buy grass-fed and organic food for your family. This is important to you because it brings happiness to your life and aligns with your personal values.
The 50-30-20 Budgeting Rule
The 50-30-20 budgeting rule is a good check on your budget to ensure that you are saving enough to put yourself in a position to retire one day. It’s a very basic rule that essentially specifies spending no more than 50% of your budget on needs and 30% on wants, as well as budgeting at least 20% for savings.
This is another broad-based rule, so it’s not going to be perfect for everyone, but the 20% for savings is common guidance in the financial industry and based on worst-case historical stock market data.
Using this same data, the 20% savings would allow you to retire comfortably in 41 years (again, assuming worst case historical data). For more information, please read, “How Much of Your Salary Should You Save?”.
Needs
Needs are those budget items that are required to live. Some examples include: shelter, food, utilities, transportation (arguably), etc.
Wants
Wants are those budget items that are not needs, savings, or investments. Some examples include: entertainment, recreational travel, vacations, boat (unless it’s required to for your income), furniture, etc.
Savings
Savings are the budget items that include your savings accounts, investment accounts, retirement accounts, etc.
Save an Emergency Fund
An emergency fund is a necessary financial item because none of us has a crystal ball. You don’t know what the future holds, so you need a pot of money available for those unpredictable financial surprises.
Emergencies include things like losing your job, having a medical emergency, accidents, etc.
If you have debt, I recommend saving a small emergency fund (typically $1,000 – $2,000), knocking out the debt as fast as possible, then increasing your emergency fund to 3-6 months of expenses.
For more information about emergency funds, please read, “Emergency Fund Guide: What, Why, & How Much Money to Save”.
What to Consider When Choosing How Much to Spend on Housing
Larger Rent Payments, Larger Emergency Fund
Something to consider when determining what portion of your income should be earmarked for housing is your emergency fund. The larger your housing expenses, the more money you’ll ultimately need to save in your emergency fund.
Financial Goals
Do you have dreams of retiring early? Do you envision an active lifestyle where you’re never really at home? Do you plan to host parties and events frequently?
Pull out your financial goals and look at your housing through this lens. Just because you can afford spending up to 30% of your income on housing doesn’t mean you need to.
If you have dreams of retiring early or don’t have housing as a high priority, consider spending less on your rent or mortgage.
If having a better place is a top priority and you’re willing to sacrifice other expenses to have a higher rent, consider spending more on housing.
Current Debt
If you have a lot of debt currently, you will be limited to how much you can afford for housing.
As a rent example, let’s say you take home $3,000 per month after taxes. You have a $600 per month car payment, a $400 per month healthcare payment, $400 per month student loan bill, and a $1000 per month credit card bill. In this scenario, you are spending $2400 per month ($2000 per month on debt) out of $3000. This only leaves 20 percent for rent, utilities and savings, so you need to rethink your budget to better meet the 50-30-20 savings rule.
As a mortgage example, let’s say you take home $6,000 gross income each month. Your expenses are the same as listed in the previous example. This would equate to a debt-to-income ratio of 33%. This leaves you 10% on your gross income utilizing the 43% mortgage lending rule and 66% of your income overall for your housing and all remaining expenses and savings. In this example, since you can only spend $600 per month on a mortgage, it may make more since to rent and pay down debt to decrease your debt-to-income ratio prior to looking into buying a home.
High Income or High Earner
If you are a high earner, you should consider spending much less on housing because you can afford to spend less and still live in a great place. This leaves you with more money to achieve your financial goals in life.
Family Plans – Children, Pets, etc.
If you are currently married with no children, but have plans to start a family soon, you should consider your future plans in determining what percentage of income should go to housing.
It’s much easier on you and your family if you consider this early on because, although you can always sell a house or rent a cheaper place, it’s much easier to factor this in now and not have to go through major life upheaval later on.
For instance, if utilizing 30 percent of your income for rent will leave little to no room in your budget for childcare and healthcare costs associated with having a family, you may want to consider lowering how much of your income you spend on rent. As an added bonus, you’ll be able to save or pay down debt with any savings you have from having a lower rent until your family situation changes.
Location
When considering what percentage of income should go to housing, you should consider the location of the housing.
If the location of the housing cuts down on other expenses, examine how much money and time it saves and consider that in your decision-making process.
For example, let’s say you have two areas you’re looking at because they are both safe areas, are affordable, and have great schools for your family.
Of the two areas, one is within walking distance of work and one is an hour away. In the area closer to work, rents are typically in the $1,500 per month range while the area an hour away has rents that typically run around $1,200 per month.
The rentals close to work will save you 2 hours each day and $200 per month in gas and car expenses. They also give you an opportunity to work up to 2 more hours of overtime which will lead to an additional $400 – $800 per month
When comparing the two rental areas and taking the whole picture into account, you may decide to spend a little more on rent, knowing that the two averages are very close, that you’ll have the ability to make more (if you execute that option) and that you’ll have a higher quality of life closer to work.
Safety
Wherever you end up living, you need to feel safe. This could mean spending a little more on housing each month to live in a better location.
It’s hard to quantify this part of the decision-making process. In a nutshell, don’t sacrifice your safety to spend a few less dollars in housing each month. Safety is one of those “needs” discussed earlier in 50-30-20 budgeting rule section. If you need to spend a little more on rent to feel safe, consider making up the difference in other budget items.
Utilities
When considering what percentage of income, you should spend on housing, determine how much the utilities will cost on average. Make sure to add the utility expenses to your cost per month for rent or home ownership.
This can make a big difference when comparing housing options and determining how much you can afford.
For example, let’s say you can afford $1,200 per month on rent. You find a great rental that charges $900 per month on rent. It’s an older place, but you don’t mind, so you move in. You quickly find out that the utilities are easily $400 per month and outside of your budget range.
As another example, let’s say you have $1,300 per month to spend on your housing budget. You find two great houses for sale, one is an older house that costs $900 per month in escrow payments (mortgage, insurance, HOA, etc.), the other is newer and charges $1,100 per month for escrow payments. You anticipate that the newer house will make up for the additional housing costs when you factor in utilities. Just to be safe though, you ask for the utility bills to verify. To your astonishment, they are comparable on utility costs. It turns out the older house has had work done to improve the efficiency of the home. If you had never performed your due diligence, you may have wasted $200 per month on housing.
Roommates
If you can find roommates or already have roommates lined up, factor this into your decision on how much of your income you can spend on housing. If you have roommates, you may be able to afford a nicer place to live. The caveat is that if you lose a roommate, you’ll need to make up the full rent until you can find a replacement or be prepared to move to a new housing arrangement.
Down Payment
If you’re planning on owning a home, something you should consider is your down payment. The larger a down payment, the less you’ll end up paying each month on your mortgage. Also, having a larger down payment will grant you more favorable terms and conditions on your mortgage.
Mortgage Terms and Conditions
Again, if you’re planning on owning a home, the terms and conditions are very important to your overall financial picture. When it comes to owning a home, you need to think about more than just a monthly payment.
You need to think about the length of the mortgage, what the interest rate is, any penalties for prepayment, mortgage insurance, etc.
For example, let’s say you are looking at buying a home and have narrowed down the options to two homes.
One is valued at $225,000 and will cost $1,500 per month in escrow costs. You are paying for a 30-year loan, the interest rate is 8%, and you only have a 5% down payment, so you also pay an additional $100 per month in mortgage insurance.
The other is valued at $150,000 and will also cost $1,500 per month in escrow costs. You are paying for a 15-year loan, the interest rate is 7%, and you have enough for a 10% down payment. You still end up paying an additional $90 per month in mortgage insurance.
For the sake of this example, both are in great areas and will meet your needs equally. Although, they both cost $1,500 per month, the second option is a much more attractive choice because you’ll pay off the loan in 15 less years and pay much less overall over the life of the loan.
Having a paid off loan will give you the flexibility to purchase investments (property, stocks, etc.) or even upgrade your living arrangement the remaining 15 years and still be ahead financially.
Marketability of Your Home
When buying a home, you need to think of how easily it will be to sell the house if something happens. Look for great school districts, safety scores, and jobs data. If you have a good real estate agent, they should know where these areas are and be able to narrow your search for you.
It may mean buying a smaller house in a great area to meet your housing budget.
Conclusion – What Percentage of Income Should Go To Housing?
To recap, there is no one-size-fits-all answer to, “what percentage of income should go to housing?”. It depends on your current financial picture, what your financial goals are, and what options you have available to you for housing.
Once you’ve identified these variables, make sure to factor them into you decision-making process.
Armed with this information, it should become clear what percentage of your income you should spend on housing.
What percentage of income do you spend on housing? How did you decide?