One of the most frequent questions that I get asked by my friends and family is, “How much do I need to buy ________?”
I work with clients daily to help them determine how much they can afford to pay for certain items. So, my loved ones trust me to advise them on what they can afford. Unfortunately, a simple answer isn’t always what they get or are looking for.
That being said, the industry offers several benchmarks that—for the most part—everyone agrees on. Here are the ones related to affording everything from renting and major purchases to credit cards and savings.
How Much Rent Can I Afford?
Benchmark: Keep rent under 1/3 of your take-home pay
Buying your own house has always been a huge part of the “American Dream.” What if you’re not quite ready to purchase a home? Maybe you live in an expensive market, are still saving, or, perhaps you see yourself moving to a new city within the next couple of years. Either way, renting may be a better option for you. After all, some debate whether it’s better to rent or buy a home, especially during the recent uncertain economic times.
No matter your reasons for renting, your monthly rent should generally be no more than 1/3 of your monthly take-home pay.
This may seem low, considering your residence is most likely the largest expense you’ll have each month. At the same time, you’ll 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 streaming service or go out to dinner to hang with friends. Beyond leaving space for living expenses, this will also preserve income to appropriately save for your future.
How Much Car Can I Afford?
Benchmark: Keep expenses under 20 percent of your take-home pay
One of the first major purchases people make on their own is a new or used car (find out if it's better to lease or buy a car). Whether you've finally landed that first real career job or the promotion you’ve been vying for, people tend to reward themselves with a fancy luxury sedan, behemoth SUV, or attention-getting sports car. Don’t get me wrong; there’s nothing wrong with that… as long as they’re rational about the vehicle they pick by stacking that up against your full financial plan.
Obviously, with the purchase of a car comes monthly car payments. As a rule of thumb, you shouldn’t pay more than 20 percent of your take-home pay on car-related expenses. That doesn’t mean that if you take home $6,500 monthly, your car payment should be $1,300. But don’t forget that owning a car involves numerous additional expenses, including insurance, maintenance, gas, etc. Be sure to consider those things while shopping for your next vehicle.
Want help calculating what you can afford to pay for a car? Check out this car payment calculator.
How Much House Can I Afford?
Benchmark: Keep the PITI below 28 percent of your gross income.
If you’re looking to purchase a home for the first time or looking to buy and sell a house at the same time, I have two things to say: 1. Wow, congratulations! 2. Good luck with that! I bought my first home quite some time ago, and it was the best—albeit most overwhelming—thing I’ve ever done. I learned vital lessons to pass on and save you from a massive headache in the long run.
When calculating how much mortgage can I afford or how much condo can I afford, use PITI (Principal, Interest, Taxes, and Insurance). Pay close attention, noting that PITI is your total monthly expense, not just the principal and interest payments! Real estate taxes and homeowners' insurance are often escrowed into the monthly payment for your mortgage. This means that these expenses are added to your principal and interest. Ideally, PITI should be lower than 28 percent of your gross income when it comes to salary to home price. (Gross income equals your top-line salary before taxes, insurance, and retirement savings are taken out.)
Two special notes when buying your first home: first, private mortgage insurance. If you are putting down less than 20%, you'll be asked to pay private mortgage insurance, essentially covering the risk of the provider for lending money to someone who doesn't have a full down payment today but is otherwise qualified. Factor this into your PITI calculation. Second, stay aware of local, state, or federal homeownership incentive programs. The size of credit can vary, but particularly with interest rates on the rise, look for programs that can help reduce the total amount lended, but also be aware these programs often come with a commitment to stay in the home for a set period of time as a primary residence.
Want help calculating how much home loan can I get? Check out this how much house can I afford calculator.
How Much Credit Card Budget Can I Afford?
Benchmark: Pay off the balance in full each month
To me, this answer is the easiest. Ideally, you should be able to pay off your entire monthly credit card balance without eating into savings. That means you can afford to charge an amount equal to what’s left in your checking account after you pay your bills and contribute to your retirement savings—something everyone should be doing. If you can do that, you’re living within your means and can afford your credit card bill. However, things come up and any personal finance professional will tell you thanks to compounding interest, credit card debt is a very common concern. There are ways to pay off your credit card debt when it gets out of control, and because of high interest rates this will likely be a top priority when you start working with a financial advisor who develops a financial plan for you.
The time for retirement planning is now — don’t wait.
How Much Can I Afford to Borrow?
Benchmark: Keep the debt-to-income ratio below 30 percent
How much can I borrow? A personal loan primarily depends on your debt-to-income ratio, whether for emergency expenses, car repairs, dream vacations, home renovations, or other reasons. While some lenders may offer loans exceeding 30-40 percent, you must be mindful of how much discretionary income you have to spare. Your loan payment should be well below 36 percent after all your expenses are considered.
Learn how to put your finances on autopilot by automating your income, expenses, and investments!
How Much Savings Should I Have?
Benchmark: Save 10 percent for basics, 15 for comfort, and 20 to escape
The final benchmark I leave you with is the percentage of your income you should save. I can still hear my father telling me: “Always pay yourself first!” That goes along with the old adage, save 10 percent for basics, 15 percent for comfort, and 20 percent to escape.
It's easy to overlook, especially when you're young, but make sure you’re building retirement and emergency fund savings into your budget when determining the amount you can afford for large purchases. While every dollar saved is important for your financial independence, a dollar saved and invested when you're 28 years old will have significantly longer to grow with interest over time compared to a dollar saved when you're 55.
See this series of blog articles on savings rate vs. rate of return and investing by age.
Check Your Financial Decisions With Our Free Analysis
Remember: These benchmarks help answer "how much can I afford to buy?" are for the average household. If you plan to spend 50 percent of your income in any given year on traveling or paying off student loan debt, deduct that amount from your total take-home income. Then, use the benchmarks to calculate what you can afford.
It's not a one-size-fits-all answer. However, with a bit of math, you can feel more confident in your financial decisions. If you’re still unsure whether you’re making the right decisions, take our free analysis. The results will tell you where to improve to get the most out of your money.
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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.
