The rent to income ratio is a percentage that shows how much of your gross monthly income is spent towards your housing expense. A good rent to income ratio is at about 30% or lower. However, this 30% may not be attainable for a home or apartment in the area you are living in.
For the majority of the United States, the income requirements for owning a home is not necessarily a realistic option. Home prices can be very expensive, and paying a monthly mortgage payment can give you debt you will be paying off for the next 15-30 years. If you are like many people, becoming a renter is the next best option to pay for your living. About 37% of houses in the US are rented, and many more young people rent affordable housing in their early years of adulthood. Renting is a much more affordable alternative to buying your house, and gives you the flexibility of being able to move from place to place without needing to sell your home. While you can't reap the benefits of your home or apartment increasing in value if you rent, you do not need to worry about losing money if the real estate value drops.
Unfortunately, rent prices can be expensive. If you live in a major city, or a state like California that has a very high cost of living, you know that your rent can be very expensive and might even be getting even more expensive. In reality, there's a strong likelihood that your rent payments are what you spend most of your paycheck money on. You may even be overspending on your rent and should consider finding a new place to live!
Did you know there's a way to tell if you are being overcharged for your rent? It's called the rent to income ratio. Let's take a look at the rent to income ratio so you can be better informed about your rent cost and what you should do about it going forward.
As we mentioned, the rent to income ratio is a metric that allows a prospective tenant to see how much of their monthly income is typically being spent towards your rent payments. If your rent to income ratio is 50%, you are spending half of your monthly income on making payments to your landlord for rent. The rent to income ratio is a great way to put into perspective how your rent payments fare against your other expenses. If you have high rent to income ratio, it could mean you are overspending on rent. If you have a cheap one, it could mean that you found a good deal with your rent or are making a good deal of money in comparison to how much your rent costs.
Landlords also use the rent to income ratio to see if their potential tenants will be able to afford the cost of rent before they approve their rent application. Many landlords look at tenants’ credit score and credit report as well as their monthly income before they allow you to rent real estate. Many landlords won't let tenants rent their property if they think the rent will be too expensive for the tenant to afford!
The rent to income ratio is a great tool to decipher rent affordability at the property. There is a chance that your landlord is not diligent or does not have your best interests in mind, and they may allow you to rent their property even if you won't be able to afford the rent each month. For your own sake, it is a good idea to calculate your rent to income ratio for your potential property.
If the rent to income ratio for your potential property is high, you know that too much of your net income will be spent paying off your housing cost. This could cause you to have to sacrifice money in other areas of your monthly expenses. Paying too much for rent is not only stressful but it is not financially smart. Make sure to check the rent to income ratio of your next property so you can know if you've found a good fit or if you should move on with your home or apartment search.
Similarly, calculating the rent to income ratio of your current place can help you determine if you may be overpaying for your rent. If your rent to annual income ratio is way too high, you know that too much of your monthly budget is being spent to make rent payments and something must be done. If your current rent to income ratio is too high, you should consider renegotiating your rent with your landlord or begin looking for new properties to rent once your current lease is up. Don't overpay for rent if you don't need to!
Likewise, calculating your rent to income ratio for your current property or your next property can help you see if you are underpaying, or in other words, have found a great deal on your rent! Great deals on rent are not too easy to come by, so utilizing your “rent calculator” can help to make sure you know when you have found one. If your rent to income is on the lower side, below 25% or so, you just may have found a bargain on your property. You may want to think twice about moving to a different space with a higher rent to income ratio, as you will have less money each month to spend or save if you choose to move.
On the other hand, if you are looking for properties and you find one with low rent to income ratio, you may want to highly consider moving to that space as you may have found a good deal. Make sure to check if there is a reason the rent is cheaper so you don't get blindsided by issues with the space you didn't know about. Overall, if you are renting a space with a good rent to income ratio, you will be spending less on rent and more on important things like debt repayment, saving, or investing.
The short answer is ALL of your income should count. When calculating your rent to income ratio you’ll want to divide your monthly rent by your monthly ‘gross income’.
Under 26 U.S. Code § 61, gross income is defined as, “all income from whatever source derived, including (but not limited to) the following items: Compensation for services, including fees, commissions, fringe benefits, and similar items; Gross income derived from business; Gains derived from dealings in property; Interest; Rents; Royalties; Dividends; Annuities; Income from life insurance and endowment contracts; Pensions; Income from discharge of indebtedness; Distributive share of partnership gross income; Income in respect of a decedent; and income from an interest in an estate or trust.”
Said another way, all of your income should be counted and this number should represent your total income prior to taxes or other legal deductions.
You now know what the rent to income ratio is and how it can be used, but what is a good debt to income ratio? While the number is disrupted and some argue it may not be realistic, the consensus is that a good rent to income ratio for your financial health is around 30%. This means that if you make $5,000 a month, you want your monthly rent to be around $1,500. If you make the same amount of money but your rent is $2,000 a month, your rent to income ratio is now 40% and your rent may be considered too expensive as a tenant.
This 30% figure is not just a random figure. Many people in the personal finance world recommend having a 30% rent to income ratio. Even the government has been recommending this percent since the 1980s. The government holds that anything over a 30% rent to income ratio is considered a "housing-cost burden" and anything over 50% is a "severe housing cost burden." Likewise, the Federal Housing Association believes that a 29% rent to income ratio is fair if you have debt, but can go up as high as 41% if you do not have any debt.
Overall, in terms of financial health, 30% is a fair rent to income ratio, especially if you have debt. A 31% or 32% rent to income ratio is fine as well, but know that as that percent increases you are increasingly overspending for rent. While this 30% is a safe figure to go off of, it is not without its flaws. Let's look at some of the ways this 30% rent to income ratio falls short and may not apply to every tenant perfectly.
While the rent to income ratio is a great metric to use for most tenants, it is not without its shortcomings. While you are still encouraged to use this metric, these are some of the things you should know about the rent to income ratio that you should keep in the back of your mind when using this metric for rent payment.
Not everyone will be able to properly use this metric. While it should still be considered at all times, 100% of people renting or looking to rent won't be able to use the 30% rent to income threshold perfectly.
If you have a great deal of debt, whether it be from student loans, auto loans, or other personal loans, a 30% rent to income ratio might not be right for you. With allocating 30% of your income to your rent, you may not be left with enough money to make all of your monthly debt payments as well as pay taxes, and have money for essentials like food and utilities. You may have to look for places with lower rent to income ratios that might fall in the 15%-25% range, depending on your debt situation.
Even if you don't have debt to deal with, a 30% rent to income ratio can still be a problem, but for the opposite reason. It is simply a matter of fact that rental costs can be more expensive depending on where you live. The average San Francisco rent will be more than the average rent in Birmingham, Alabama or Mesa, Arizona for example. While wages may be higher in places with a higher cost of living, they may not be. There is a chance that it is simply just more expensive to live in these areas. This could mean that most of the people renting in that area have very expensive rent prices. Rent could be so expensive that the average rent to income ratio of the entire area could be upwards of 40%-50%!
For example, according to First Tuesday, a rent to income of 30% of the average income in San Francisco amounts to about $2,500. In other words, tenants in San Francisco should not try to spend more than $2,500 on rent. However, the average rent for a 2 bedroom rental is nearly $3,100. In order to meet this 30% rent to income ratio for the $3,100 rent, the average potential tenant in San Francisco must make an additional $24,500 a year. Quite the raise. See the problem here?
Finding an apartment or house to rent with a 30% rent to income ratio simply might not be feasible for the area you work in or want to live in. No matter how hard you look, there simply may be no place that meets the 30% and you could be out of luck and forced to live with high rent to income ratio. Chances are, you aren't going to find a rent to income ratio of 30% in downtown Los Angeles or New York City if you are a typical tenant. Take into consideration this reality when using this metric.
If you are dead set on living by the 30% rent to income principle, you are likely going to have to move farther out of town to find a place that meets this 30%. This means that your commute will be longer, which no one enjoys. You may even have to move far enough that the additional money you spend on gas is more than the money you are saving on rent! That's no good!
As you can see, the principle of having a 30% rent to income ratio does not fit every scenario. It simply does not hold true in areas that have an overall higher average rent than the rest of the country. It also does not work for those who have plenty of debt and need to prioritize paying it off. However, for most parts of the country, a 30% rent to income ratio is a good principle to stand by. It is a personal finance principle that is heavily supported by the government. It can ensure that you are not overpaying for your rent so you can spend your money on things that are more important to you!
You now know that rent to income ratio is the primary metric that landlords look at when screening a potential tenant, but the second most important metric is the debt to income ratio. The debt to income ratio is the total amount of debt payments you have to make each month divided by your gross monthly income. This ratio is one of the ratios that both landlords and lenders look at prior to doing business with an individual. If the renter applicant has no or little debt, the landlord will be more comfortable with a higher rent to income ratio.
If you’re a landlord, you or someone you employ will spend most of their time completing maintenance requests and chasing down rent payments. We can’t help you with your maintenance issues, but there are some easy ways to encourage your tenants to pay on time.
The first step is developing and signing a rent agreement that highlights when rent is due and the penalties for late payment. This requires hiring the right legal partner to draft your agreement, but it is also about having clear verbal and written communication with your tenants.
If tenants are experiencing difficulties paying on-time, communicating the penalties or fees they will be charged upfront is often best. If the tenant’s behavior does not improve, you’ll want to send them a letter informing them that you intend to report them to the credit check bureaus.