For those who stay in rented accommodation and have to pay a monthly rent, a question that would have bothered them is what percent of their total income should they spend on rent? This is an important question as it helps them to plan their budget. Once they know how much money to spend on rent, they can then plan how to spend or save the money left over
Know your income
First thing, of course, is to know how much income you are earning. One needs to consider the net income and not gross income. This means the income after deduction of contributions and payment of tax has to be considered. Income for all sources needs to be considered, in case you have income coming every month from any other work that you do. Divide the total income by 12, so you can know your monthly income. This is the starting point before you decide how much to spend on rent.
The 30 percent rule
A common rule followed by most people is the 30 percent rule. According to this rule, you must not spend more than 30% of your monthly income on rent. For instance, if you earn $4,000 as your income every month (after deducting taxes), then you must not spend more than 30% of this amount, i.e: $1,200 for rent. You need to look for a home or apartment where the rent is $1,200 or less. This allows you to save 70% which can then be allotted for other essential expenses and savings.
This rule is a conservative guideline and has been followed from years. However, this rule does not work everywhere. For example, in a city like New York, $1,200 may not be enough to get decent accommodation.
The 30 percent rule does not work
In practical situations, the 30% rule may not work out. In big cities, 30% of income may not be sufficient to ensure one gets a decent accommodation. Each individual’s financial situation is different. Those who have children will have to consider expenses for schooling and other needs. Those who stay alone may have more money to spend. So, each person’s financial position is different. Hence a fixed 30% rule may not be realistic. Some amount of tweaking may be needed.
This is a better option as compared to the 30 percent rule as it offers more flexibility. This rule was originally put forward by Senator Elizabeth Warren[i]. According to this rule, one should reserve 50% of the income earned for one’s needs. This includes rent, grocery, utility bills, insurance, and fuel. 30% should be spent on wants, like shopping, holiday trip, eating out, movies. 20% should be saved for the future.
This rule gives flexibility as rent and other basic expenses are included in the 50%. This helps in increasing the rent amount if you stay in a big city. If you are having problems balancing your budget, you can always reduce the expenses on wants and add it to the needs. That will help you spend the right amount for rent.
While 30% of income was the standard answer for how much of income to spend on rent; the 50:30:20 rule allows for more flexibility. 50% income can be devoted to rent and other basic wants.