Renting an apartment or buying a house, the general question that flows through the average persons’ mind is how much of the total income should go into housing as a whole. Housing is the biggest line item in the budget for most households, but it’s extremely difficult to know how much you should spend. Pooling your total income into housing alone is a very bad idea. There are other bills, savings, and even some non-essential spending.
The 30% Rule of Thumb
An old rule of thumb suggests that not more than 30% of your income should go into housing each month. The 30% rule of thumb dates back to the National Housing Act of 1937. This act opened the public housing program for low-income families, and it maintained guidelines for maximum rent. The 30% rule has been established as a qualification ratio for mortgage lenders. Some private house owners require their tenants’ annual salaries to be three times their monthly rent. This leaves 70% of the monthly salary to cover other needs.
Why Is the 30% Rule Wrong?
The 30% rule has two major flaws. First, the rule has no regard for a possible hike in rent prices. For example, as of 2019, the average income of a US household is $42,500. If you use the 30% rule of thumb then, you have to spend $1,062.52 on the rent of a two-bedroom apartment. However, in 2021, the average amount for a two-bedroom apartment is $1,972. With this, we can say the 30% rule of thumb is obsolete.
The other problem with this rule is that it pays zero attention to your finances. It does not take into account the amount of debt you are trying to pay off, neither does it consider taxes. With this rule, there will be little to none to save for your financial goals.
How Much Income Should You Spend on Your House?
Since the 30% thumb rule is outdated, there is an alternative budgeting ratio. That’s the 50/30/20 ratio. This ratio is considered after taxes have been deducted from your income.
50% of your income goes to your “important” pool. This pool is of things that are must-dos and must-haves. This is paying rents, feeding allowances, and other essential payments.
30% of the income goes to the secondary pool. These are things that you want, not the things you need. This pool consists of designer clothing, date nights, and more.
And the last 20% goes to the savings and debt repayment pool.
This helps to strategize your income to avoid wasteful spending. It also helps to save automatically. It does not necessarily have to be this exact ratio. Once you notice a slight decline on one part, it is flexible enough to cover up for the other.