One of biggest factors affecting our day-to-day lives is where we live. There can be many possible hopes and joys surrounding it. For most of us, those hopes and joys are constrained by what we can afford to spend on rent.
How Much Should I Spend on Rent?
The traditional way to budget for rent has been as percentage of income – typically 30 percent of gross income. For example, if your monthly gross income is $5,000, then rent should be $1,500 per month. However, you’ll be better served by taking these considerations into account as well:
Retirement savings. First, keep in mind that rental expense is a true expense that takes funds away from your savings. The younger you are, the more time you have for savings to compound for retirement. For example, $1,000 saved at age 25 would grow to over $7,000 by age 65, assuming a return of 5 percent annually. So an important way to look at rental expense is the tradeoff between your current lifestyle and retirement lifestyle. Take care not to compromise your future lifestyle for the sake of your current lifestyle.
Savings fluctuations over time. For most Americans, savings are highest before and after children. For example, a young, childless, dual-income couple will have relatively low expenses relative to income. Similarly, an older couple whose children are out of college will also have relatively low expenses. Having and raising children is costly, and the ability to save is the lowest during that middle period of life if you have children. That fact, combined with the power of compounding, means that saving money for retirement is the most important early in life, especially before having children. So even if you have a good amount of income, it is important to manage expenses such as rent carefully when you’re young.
Down payment on a home. Economizing on rent when you’re young can also allow you to save for a down payment to buy a home. In general, owning is cheaper than renting if you stay in the same place for six years or more. Also, owning a house and paying off the mortgage will hopefully result in a debt-free asset in retirement, with low monthly overhead when income is also low. Therefore, it makes sense to save on rent when you’re young and put the savings toward a combination of retirement and a down payment on a house.
Discretionary spending. Another useful way to look at rent is as simply another discretionary expense that can be traded off versus other discretionary expenses. For example, you can save on rent to spend more on entertainment and dining out. Or you can do it the other way around: Limit meals out and entertainment in order to afford a nicer place to live. Either way, there is a tradeoff to be conscious of and make according to your priorities.
Saving on rent with a roommate. Consider a roommate to save on rent and be able to afford a nice place in a good location. This can help in so many ways. For example, you will be able to split not just rent, but also the cost of electricity, internet service and other utilities. With the right roommate, you will also enjoy the added benefit of having a friend that you enjoy spending time with. Obviously, the wrong roommate can make life very unpleasant. Still, you can very likely save 50% on rent with the simple decision to have a roommate. But choose that roommate carefully.
Paying more when it gets you a better job, location and lifestyle. There are instances when it really makes sense to pay higher rent. For example, it can makes a significant difference in your quality of life, such as by reducing your commuting time or allowing you to live closer to loved ones or your workplace.
The real estate adage “location, location, location” holds a lot of truth. Location makes a lot of difference in the overhead involved in the daily orbit of our lives – to work, school, stores and friends and family. Therefore, it is worth paying up for the right place at the right location, if that results in significantly improved quality of life.
Consider not using the 30% of gross income as a rule of thumb, but as an absolute maximum. The less you spend on rent, the more you can save for retirement and a possible house purchase. Also, you will have more left over for entertainment and other discretionary expenses. In addition, the right roommate can help you save and simultaneously add to the quality of your life. With all that said, consider paying more in rent if it gets you significantly better quality of life.