How Much to Spend on Housing Based on Your Income

by Wilhelm Schnotz, Demand Media
    Buying a home can be the most exciting moment in a couple's life together, but it's good to remember that housing expenses are often the largest expenses in a household budget.

    Buying a home can be the most exciting moment in a couple's life together, but it's good to remember that housing expenses are often the largest expenses in a household budget.

    It’s impossible to develop any sense of financial stability if you don’t develop a household budget, and when you’re a first-time homebuyer or leasing more than a cramped studio apartment, that budget becomes even more important. Instead of developing a budget around your living expenses -- a decision that can be tricky, even disastrous at times -- it’s best to develop your budget first, and find a place to live within your means.

    The 28/36 Rule

    Unless you’re super rich or struggling to make ends meet, most financial advisors recommend that you spend about a third of your monthly after-tax income on your housing needs. Mortgage lenders take it one step further, and often apply the so-called 28/36 rule to their clients, which declares that households shouldn’t spend more than 28 percent of their monthly budget on housing, and shouldn’t allow the total of their housing and debt costs – such as student loans and credit card debt – to exceed 36 percent of their monthly income. Because of this, how much of your income you should budget for housing may hinge on your existing debt load.

    By Pretax Income

    Some mortgage lenders, such as Bank of America, prefer to calculate your ability to cover a mortgage based on your pretax earnings. Depending on the lender, guidelines vary, but the guidelines set by Fannie Mae and Freddie Mac allow you to budget between 35 to 45 percent of your pretax income for housing, mortgage insurance, property tax and all other debt, such as car loans and student loans. These guidelines, of course, are just guidelines -- the actual standards used by some lenders will be more strict, and you might want to keep your own restrictions for housing costs on the low side as well, since spending 45 percent of your pretax income on debt will leave precious little room in most incomes for savings, emergencies and fun stuff.

    Historical Perspective

    The 28/36 rule is a modern invention, and by no means should it entice you to spend more on rent or a housing payment than you need. In 1901, the average household spent 23.3 percent of its income on housing, according to the Bureau of Labor Statistics, leaving 20.2 percent as discretionary income. Of course, only 19 percent of Americans owned their home, versus 65.9 percent in mid-2011.

    Why It's Important to Budget Housing Costs Correctly

    When your budget gets tight, you can stop buying new clothes and or skip a night on the town in order to help balance your household budget. Your housing costs, on the other hand, are generally fixed and can't be so easily trimmed. Because you’re likely to enter into a lease or be paying a mortgage, it’s impossible to adjust this expenditure when you need to tighten your belt. By determining a reasonable amount of your income to budget for housing ahead of time, you’ll allow yourself some flexibility in the future in case of a sudden financial calamity.

    About the Author

    Wilhelm Schnotz has worked as a freelance writer since 1998, covering arts and entertainment, culture and financial stories for a variety of consumer publications. His work has appeared in dozens of print titles, including "TV Guide" and "The Dallas Observer." Schnotz holds a Bachelor of Arts in journalism from Colorado State University.

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