Yesterday the Wall Street Journal’s Developments blog (it covers real estate) carried a post Is Your Rent Too Damn High? inspired by a classic only-in-New-York character, Jimmy McMillan, the Rent is Too Damn High Party’s candidate for governor. The photo alone makes it worth the click.
The post muses, without resolution, on the eternal question of how high is too high.
Many personal finance experts say you should spend no more than 35% of your gross income on rent (not including renter’s insurance) whether you live in a high- or low-cost area. Of course, this amount can mean the difference between living in a studio on the outskirts of an expensive city or living large in a condo overlooking the beach in a low-cost area.
Many experts say this? It is the sort of faux wisdom that is often attributed to unnamed others and then passed on half-heartedly. I spent several minutes looking around the web for first hand advice on how much to budget on rent. I didn’t find much. There is lots of stuff out there on how big a mortgage you should take on, but relatively little discussion of renting. I guess renters just aren’t interested in personal finance.
Dave Ramsey is fairly typical in his recommendation of renting as a useful temporary stage before you save up enough to buy a place. Once you buy, he says to make your housing costs no more than 25% of your take-home pay. Presumably, he would recommend an even smaller percentage for rent.
I also found this voice-in-the-wilderness paper from the US Census Bureau from 2005, which cites 30% of income as the maximum of affordability, which is to say that above that level housing is considered unaffordable by government mandarins. But the paper makes it clear that this is a completely arbitrary figure and provides short bureaucratic history of it.
(The paper is also evidence that even in Washington some people saw the debacle coming in 2005. The first sentence reads “With creative financing in the present day housing market, housing values are increasing and homeowners are taking chances with alternative financing methods and consequently putting their homes on the line.”)
If you have been reading this blog for any length of time you know that I think that the idea that there exists a correct percentage of income to be allocated to rent (or savings, or just about anything else) that would make sense for most people is bunk. There are just too many variables involved in each individual’s situation. Folks need to understand how to come up with the right answer for themselves. Even a percentage given as a guideline is too inaccurate to be very helpful.
The dangerous thing about rent as a percentage of income is that it is a relationship that almost makes sense. In contrast, prescribing a percentage of income to most other expenditures would be so obviously loopy that nobody would take the suggestion seriously.
Maybe the biggest variable when it comes to rent (and real estate costs in general) is what part of the country you are living in. That is true about some other things too. But if I were to suggest that a person should spend a certain percent of income on winter clothes or air conditioning most would immediately see the objection that reasonable expenditures for those things are very different in, for example, Buffalo or Miami.
But rent has the property that, to a certain extent, its relationship to income self-corrects for location. Rent in New York is much higher than in Toledo, but so are incomes, for reasons that are not in the least coincidental. (I’ve never been to Toledo, BTW. I’m sure it is very nice.)
And rent is also one of those few things that is both a necessity and something that people tend to spend more on as they get richer. That is not the case with such things as food, clothing, and medical care, which make up larger portions of lower income budgets than higher income ones.
So, to a degree just sufficient to make the X% on rent idea remotely plausible, both location and income level more or less wash out of the equation. But that is not enough to make X% work.
Other big factors come into play. How much real estate you need, for example. Do you have kids? How many and what ages? Work at home? And location within a city can affect what you pay considerably. That decision could hinge on proximity to work, schools, airports, or a dozen other things.
Then there are the other expenses that are dependent on where and what you decide to rent. Paying more rent to live closer to your job versus saving on rent but paying more to commute is an obvious example of a tradeoff to consider. (New York and Los Angeles are often grouped together as expensive places to live with regard to real estate. That is true, but it bears pointing out that people in LA must also own cars.)
And let us not discount personal preference. Wanting to rent a nicer place, even though it means spending less on other things, is no less rational than deciding to rent a dump so you can eat out and travel more.
There exist those who appropriately spend 50% of income on rent and there are those who are spending too much at 20%. (A junior Wall Street analyst who walks to work and his embarrassingly well-paid boss, perhaps?)
The weird thing about the 25% or 30% on rent rule is that it may be less of a description of the advice of personal finance experts than a description of the way most people actually think about rent and housing expenditures. I remember reading somewhere that people who move from one city to another tend to spend the same amount on housing, no matter how inappropriate that may be in the new town. People are not comfortable with actually making a decision about how much of their income to spend on real estate so they just go with a percentage that sounds reasonable and that they see thrown around here and there.
[Photo – Infrogmation]