Rethinking the 30-Percent Rule
They say you shouldn’t spend more than 30 percent of your income on housing costs, but does this advice hold up today?
November 18, 2021
You may have heard the age-old rule of thumb for housing costs which says that you should never spend more than 30% of your salary for the roof over your head. For instance, if you make $36,000 per year — $3,000 per month — you shouldn’t pay more than $1,000 in rent or mortgage costs.
Does this rule hold up in the modern era with the soaring housing prices and stubbornly low wage growth?
The world has certainly changed since the concept was introduced. In 2021 and beyond, it may be time to rethink the 30-percent rule.
Where did the 30-percent rule come from?
The 30-percent rule is a result of the Brooke Amendment — legislation that was passed in 1969 and adjusted in 1981. The amendment capped rent in public housing at 25% of the tenant’s income, and it was later adjusted to 30%.
The Brooke Amendment applied only to public housing and was never intended to be considered as a general rule of thumb for rent costs.
Nonetheless, the 30-percent rule was widely adopted by financial advisors and led to a long-lasting belief that Americans should spend no more than 30% of their gross income on their home payments.
Does the 30-percent rule still apply?
There are a couple reasons why it may be time to rethink the 30-percent rule: rising housing costs and slow wage growth.
Housing costs
Between 1980 and 2020, the median monthly rent in America has surged from $243 to $1,104 per month.
House prices have increased even more dramatically, with the average price of a home sale in the U.S. rising from $73,600 to $383,000 in the same time frame.
It’s worth noting that lower interest rates have made buying a home slightly more affordable on a monthly basis, but average costs are still rising fast.
This data clearly shows that housing prices for both renters and buyers are increasing rapidly. If incomes are also rising, is that a big deal?
Income levels
Household income in the United States is certainly rising, but it’s simply not keeping up with the increase in housing and other living costs.
In 1980, the median household income in the U.S. was $21,020 per year. In 2020, the median household income was $67,521 per year.
This means that between 1980 and 2020, the median household income in the U.S. increased 221%. During the same time period, rents have increased 354%, and home prices increased 420%.
This data shows that expenses are rising faster than income for the average American household.
What percentage of your income should go to rent?
Since the 30-percent rule may not apply for all situations, you might be wondering how to budget your housing costs. The answer depends on a number of factors, including:
Your location
Your other fixed expenses (student loans, car payments, utilities, etc.)
Your income level
The number of wage earners in your household
Whether you have roommates
Your financial goals and overall financial health
Of all the factors, location makes the biggest difference in your expenses and your income. Data compiled by CNBC in 2019 showed that the average rent-to-income ratio was 40% in New York City, 42% in Miami and a whopping 45% in Los Angeles.
On the flip side, the average ratio in Bloomington, Illinois was only 13%.
What this means is that a healthy income-to-rent ratio for a single software developer in San Francisco may look a lot different than the ratio for a married couple who teach in rural Michigan.
Housing cost guidance
Expert opinion and advice varies, but there are some general rules of thumb to keep in mind.
30-percent rule
Despite all its flaws, the 30-percent rule still provides a decent starting point for figuring out how much rent or mortgage you can afford. Try not to think of it as a hard-and-fast rule — you’ll need to consider your individual circumstances.
Landlord income requirements
If you’re renting, the landlord or property manager may have specific requirements for your rent-to-income ratio. The industry standard is that income should be three times the rent. In other words, to lease an apartment renting for $1,500 per month, many landlords would request that tenants make at least $4,500 per month in gross income. This is actually very close to the 30-percent rule, as it works out to 33.33%.
Mortgage income requirements
If you’re looking to buy a home, the mortgage issuer will have strict requirements for your debt-to-income ratio (DTI). Loans backed by the Federal Housing Administration (FHA) typically require a DTI of no more than 31%. Your ratio will affect your ability to get a mortgage as well as the amount of money the bank is willing to loan you. Learn how to calculate your debt to income ratio here.
Other lenders may use your back-end DTI, which looks at your income compared to total monthly debt payments, which include mortgage, student loans, auto loans and credit cards. FHA loans typically require a DTI of no more than 43%.
50/30/20 rule
The 50/30/20 rule states that 50% of your income should go to needs, like rent, 30% should go to wants and 20% should go to savings and investments — and extra debt payments. This rule typically looks at after-tax income.
This budgeting approach doesn’t specifically indicate the appropriate level of spending on rent, but it provides a helpful bird’s-eye view of what your total spending should look like. If you can follow this budget, it doesn’t matter too much whether your housing eats up 15% of your budget or 35%.
Bottom line
There is no hard-and-fast rule for how much of your income should go to rent. If you can, it’s helpful to keep your housing costs below 30% of your household income.
If that’s not possible, don’t be discouraged — the 30-percent rule is increasingly out of reach for many of us. As long as you are actively taking steps to improve your financial situation, you are on the right path.
One way to do that is to work on lowering your DTI by paying off credit card debt with the help of a tool like Tally†. Use the Tally app to manage monthly payments, and see if the Tally line of credit can help you get out of debt faster.
†To get the benefits of a Tally line of credit, you must qualify for and accept a Tally line of credit. The APR (which is the same as your interest rate) will be between 7.90% and 29.99% per year and will be based on your credit history. The APR will vary with the market based on the Prime Rate. Annual fees range from $0 - $300.