How to budget housing costs, from rent to utilities

Published 6:03 pm Friday, December 9, 2011

Question: Can you tell me how much a single person should budget for housing? What about utilities?

Answer: You didn’t say whether you are asking about housing expenses as a renter or homebuyer, so I will cover both.

As a landlord, I have a rule of thumb that rental applicants should ideally have a gross income of at least three times the monthly rental amount to comfortably afford the rent and still have money for a car, gas, groceries and utilities.

In the real world the numbers don’t always work out that way. As a landlord, I have rented properties to tenants who earned less if they had good credit and a potential for increasing income.

Remember, I am talking about gross income, before withholding for taxes. Your take-home pay would be significantly less, and if you add up all your monthly expenses, you can see that paying more than a third of your gross income for rent does not leave a lot for all of your bills, let alone many luxuries.

As for utilities, heating costs are typically your biggest expense, so the best way to control those costs is to live in a smaller home with good insulation and double-pane windows. It is surprising how much money you can save by turning off the heat when you are not home and setting the thermostat to a low temperature.

The same goes for electricity. If you leave your lights on all the time your monthly bill will be higher than someone who is very careful about not wasting power. So there is no easy rule of thumb as to how much money you should have to spend on utilities because the costs vary widely depending on energy usage.

If you are planning to buy a house, and you have excellent credit, you may be able to qualify for monthly mortgage payments that are significantly larger than you might feel comfortable paying. That was especially common in the easy money era of loose lending standards that caused the mortgage meltdown a few years ago.

When I started in the mortgage business in the early 1990s, the rule was that no more than 28 percent of your gross income could be allocated to your housing expense, which includes your mortgage payment, property taxes and homeowner’s insurance, and 36 percent of your income could be allocated to your total monthly debts, which would include your housing expense plus monthly payments for car loans, credit card bills, student loans, etc. Your monthly utility costs are not included in this calculation.

Early in this decade, with the advent of computerized automated underwriting, the housing expense ratio was no longer used and lenders concentrated only on your total debt-to-income ratio. If you had excellent credit, you could sometimes get approved for a mortgage with a total ratio as high as 60 percent to 70 percent.

Needless to say, if 60 percent to 70 percent of your gross income is being used to cover housing and debt, you have very little money left for anything else.

That’s why lenders have now tightened their underwriting standards so that today many will not qualify mortgage borrowers above about 45 percent to 55 percent debt-income ration. But even that ratio is still very high compared to the underwriting standards of 15 to 20 years ago.

So unless you want to find yourself house poor, I think it’s a good idea to try to limit yourself to a housing expense of about one-third (33 percent) of your gross income, just like my rule of thumb for renters. And try to keep your total debts (housing plus car payments, credit cards, etc.) at 40 to 45 percent, or less.

Steve Tytler is a licensed real estate broker and owner of Best Mortgage. You can email him at features@heraldnet.com.