Calculating Your Financial Ability to Pay Rent
How much rent can you actually afford to pay each month? One problem that renters often run into a few months into their lease agreements is that they find it difficult to make ends meet. This problem usually arises when landlords and tenants fail to make a realistic estimate of just how much rent can be paid each month.
When prospective tenants submit a rental application, they should take into consideration all living expenses. Too often, rental applications are approved solely based on the background of the applicants and their income; this is not conducive towards establishing a clear picture of the ability of the tenant to make monthly payments.
Rental affordability can be calculated using a method similar to the Debt-to-Income (DTI) ratio estimate used by mortgage brokers and underwriters. Landlords often go by the unwritten rule of monthly income being three times greater than the monthly rent payment, which is fine as long as other living expenses are not too high. When thinking about living expenses, one must also take into account factors such as car loans, college debt, credit cards, etc.
Rent-to-Income (RTI) Ratio
Landlords focus on 30 percent RTI ratios, which is a calculation that is essentially the same as annual income being 40 times the monthly rent. If the monthly rent of an apartment is $1000, a landlord will expect to see an annual salary of $40,000 before issuing an approval. It is important to note that combined income is used when calculating RTI, and thus a couple who works and contributes to the maintenance of a household can add up their incomes when submitting a rental application.
Calculating Home Affordability
A realistic estimate of how much rent can be afforded requires the inclusion of utility expenses and all other monthly debts. The idea is to choose a rental situation that actually fits an individual or family budget; to this effect, the net monthly income should be used instead of gross pay. The sum of all monthly payments due should be divided by the net monthly pay and divided by a hundred; this returns a home affordability percentage.
Ideally, renters should be looking at no more than a 45 percent ratio when calculating affordability. This allows for reasonable nutrition, entertainment, savings, and even investing. Alas, tenants who live paycheck to paycheck will probably have to adjust this ratio upward to 60 percent. Ratios above 65 percent tend to create financial stress.
