The age-old advice that tends to stick today is that you should budget to spend 30% of your income on rent. But these days, that guideline can be wildly misleading. For example, do you include 30% before you pay for taxes or after? Is it 30% of your gross or net income? Does that rental amount include utilities? These are all questions that may confuse you in determining your budget. So, here is the best way to plan your budget to determine what rent is affordable.
The first step in determining your rental budget is to figure out an accurate income and expense ratio. Start by calculating what your monthly income is. It's usually easier to calculate these numbers using your income after tax deductions. Then, you need to calculate all the expenses that you have to pay every month. These expenses will likely fall into one of two categories: fixed or variable.
Start with Fixed Expenses
This includes all your monthly expenses that don't change month-to-month—basically, things you have to pay for regularly that aren't optional. So, here you need to include things like student debt or loans that you need to pay off, car payments, insurance payments, health coverage, phone bills, groceries, utilities… the list goes on. You get the idea. If you have recently graduated from college and haven't yet started paying off student loans, include them now! There's a chance your loan payments will start being due during your current rental contract, so you need to budget for that. You should be able to determine what your approximate monthly payments will be, and if you're unsure, round up!
Next, Calculate Variable Expenses
Once you've figured out your fixed expenses, you should also determine your variable expenses. These are optional things you might like to spend on and that you should also budget for. We all need to treat ourselves every once in a while! Variable expenses might include things like travel, restaurants, entertainment, and other discretionary or items.
From here, you can then do the calculations to determine how much money you have leftover. Of course, you now need to consider realistically how much you need to maintain your lifestyle. Once you figure all of that out you should be pretty close to determining how much is left over for rent and what sort of rentals you can afford.
Part of making your rent expenses work so you can afford a home that you like is to implement proper budgeting techniques. Generally speaking, a good rule of thumb is to follow the 50/30/20 budget rule. You already know that the 50 refers to spending 50% of your overall income on living essentials, which will include rent. We determined that rent should be about 30% of your overall income. Thus, you can infer that you will want to dedicate about 20% of your income to other living essentials. This will include your fixed monthly expenses that we discussed earlier. However, following the 50/30/20 budget rule allows you to have a little bit of leeway with the amount of rent you can afford. If you determine that all your other living expenses only add up to 15% of your monthly income, for example, you could afford to spend an extra 5% on rent. This might make a big difference in the type of home you can afford.
The '30' means spending 30% of your income on non-essentials. Your variable expenses will fall into this category. Then, there's 20% of your income remaining, and this should be reserved for savings. It's essential to have a savings account to ensure you have finances set aside for emergencies or future goals like a downpayment on a home.
Don't be tempted to move numbers around when determining your budget to make room for more expensive rent. It's better to ensure you have extra money left over each month than it is to be constantly stressed about affording your rent or bills.
If you're self-employed, don't forget to figure out exactly how much money you need to set aside for taxes. The overall point here is, figure out absolutely every aspect of what needs to leave your bank account every month. When you sit down and get into the nitty-gritty of your expenses, you may find that you have less money to spend on rent than you might initially think. Don't let this get you down. It's much better to have a realistic budget from the get-go than to find yourself in financial hot water because you signed a 12-month lease and wildly overestimated your rental budget.