For most people, rent is either at the top or near the top of the list of most necessary expenses. That’s because consistently paying your rent is how you retain a roof over your head. Whether it requires constricting the budget in most other areas of life or raiding the savings, rent is one thing few people compromise on. But just because you always manage to pay your rent doesn’t mean you can actually afford it. This is something most people, even the ones that have been renting for years, should understand.
Debt-To-Income (DTI) is a metric that mortgage lenders use to evaluate whether an applicant can afford mortgage payments or not. Landlords use a different version (rent-to-income) to evaluate whether a potential tenant can afford rent. It’s a ratio of your monthly rent to your monthly income.
Rent-to-income = Monthly Rent/Monthly Income (You can also use annual values)
For most landlords, a 30% rent-to-income ratio is acceptable, whereas 25% or lower is ideal. This is also referred to as the 40x rule. So if your monthly income is $8,000, your monthly rent shouldn’t exceed $2,400. Otherwise, the landlord may consider you a financially risky tenant.
Looking At The Whole Picture
While rent-to-income or RTI is a useful calculator for both you and the landlord, it doesn’t show the whole picture. You can enhance this method of calculating your rent affordability by following the back-end DTI ratios the banks use. Add all the debt you carry, for which you have to make regular payments, to your rent and see how much of your income it takes.
So if you have $2,400 monthly rent, an auto loan that takes away $1,000 a month, and you need to pay at least $600 a month towards your credit card debt, that’s $4,000 in total that you have to pay each month. That’s half of the $8,000 income, and it’s not a healthy ratio.
From a mortgage perspective, the back-end ratio shouldn’t exceed 43%, and if you apply the same number to your rent, you have two options:
- You can try and negotiate lower monthly payments for your other debts. For example, you may start paying $350 towards your credit card and extend your three-year auto loan to a five-year version for a $700 a month payment. That will bring your back-end ratio to roughly 43.1%, closer to the desired number.
- Or you can rethink your rent affordability. If you can’t cut down your other debt payments and if you still want your rent plus your debt payments to remain under 43% of your income, you should rethink how much rent you can afford. With this much debt, you should look for $1,800 or lower rent a month (including monthlies). This is way below the typical rent-to-income ratio of 30% for someone with $8,000 a month income, but if you look at the big picture, this is a financially healthy choice.
Note that this calculation doesn’t take into account other necessary expenses like utilities, educational expenses, commute/fuel, etc. They may also impact how much rent you can afford in NYC.