The Age-Old Question: How Much Can I Afford?

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 Sara Gelsheimer By: Sara Gelsheimer

One of the most frequent questions that I get asked by my friends and family is, “How much do I need for ________?”

Because I work with clients daily to help them determine how much they can afford* to pay for certain items, my loved ones trust me to give them guidance on what they can afford. Unfortunately, it’s not always the simple answer they are looking for.

That being said, there are some benchmarks upon which the industry—for the most part—agrees.

1) Purchasing a Home

Benchmark: Keep PITI below 28 percent of gross income.

If you are looking to purchase a home, I have two things to say to you: 1. Congratulations! 2. Good Luck!

I purchased my first home a little over a year ago, and it was the best and most overwhelming thing I have ever done. When calculating what you can afford for a new home, be sure to use PITI (Principal, Interest, Taxes and Insurance) as the monthly expense—not just principal and interest payments. Real estate taxes and home owners insurance are often escrowed into the monthly payment with your principal and interest payments for your mortgage. PITI should remain lower than 28 percent of your gross income. (Gross income is your top line salary before taxes, insurance and retirement savings.)

Want help calculating what you can afford when purchasing a home? Check out this calculator.

2) Renting a Home

Benchmark: Keep rent under 1/3 of take-home pay.

Okay, so you’re not quite ready to purchase a home or you can see yourself moving to a new city within the next couple years. Renting is more likely a better option for you. In general, your monthly rent should not be greater than 1/3 of your monthly take-home pay.

While that may seem low, considering your residence is most likely the largest expense you will have each month, you will want to have ample money left to pay for utilities, gas, groceries and entertainment expenses. I doubt many people would enjoy living in a luxurious apartment if they can’t pay for the internet and Netflix or go out to dinner with friends.

3) Purchasing a Car

Benchmark: Keep expenses under 20 percent of take-home pay.

One of the first major purchases people make on their own is a car. Whether it’s after they land that first real job or get the promotion they’ve been vying for the past two years, people tend to reward themselves with a shiny, new car. And there is nothing wrong with that… if they are rational about the car they pick.

With the purchase of a car comes monthly car payments. As a rule of thumb, you should not be paying more that 20 percent of your take-home pay on car related expenses. That doesn’t mean that if you take home $5,000 each month, your car payment should be $1,000. Don’t forget that owning a car comes with numerous other expenses: insurance, maintenance, gas, etc.  Be sure to take those things into consideration when shopping for your next car.

Want help calculating what you can afford to pay for a car? Check out this calculator.

4) Credit Card Balance

Benchmark: Pay off in full each month.

To me, this answer is the easiest. Ideally, you should be able to pay off your entire credit card balance each month without eating into savings. That means you can afford to charge an amount equal to what is left in your checking account after you pay your bills and contribute to your retirement savings—something everyone should be doing. (See this blog for thoughts on how to make saving a reality.) If you are able to pay off your credit card balance after paying bills and saving money for a rainy day and/or retirement, then you are living within your means and can afford your credit card bill.

Remember: These benchmarks are for the standard household. If you plan to spend 50 percent of your income in any given year on traveling or paying off student loan debt, you will want to deduct the amount you plan to dedicate to those other expenses from your total take-home income. Then, use the benchmarks to calculate what you can afford.

5) Savings

Benchmark: Save 10 percent for basics, 15 for comfort and 20 to escape.

The final benchmark I will leave you with is the percent of your income you should save. The old adage reads: Save 10 percent for basics; 15 percent for comfort; 20 percent to escape.  Make sure you are building retirement/emergency fund savings into your budget when calculating the amount you can afford to spend on any large purchases.

See, it really isn’t a simple answer! However, with a little math, you can feel more confident in the financial decisions you make.

*Plancorp uses statistical analysis of each client’s situation to tailor the answer of “How much can I afford?” to him or her. While the benchmarks are a good guideline, we want to provide our clients with a more precise guideline for their situations.

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This post was written by a member of the Plancorp Women’s Initiative, which strives to advocate for clients and women in the community by addressing topics specific to their financial lives. For more information about the Women’s Initiative and how you can get involved, email sara@plancorp.com or visit the Plancorp Women’s Initiative page.

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Sara came to Plancorp in 2013 with a strong financial background and an even stronger commitment to financial education—particularly for women. A Wealth Manager and Founder of InspireHer (Plancorp's Women's Initiative), Sara is also a new mom. More »