How to calculate housing expenses

Question: Can you tell me how much of a single person’s income should be budgeted for housing? What about utilities?

D.F., Everett

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 (before taxes) of at least three times the monthly rental amount. For example, if the rent is $1,000 per month, the renter should have a gross income of at least $3,000 per month (3 x $1,000) to comfortably afford the rent and still have enough money left over to pay for a car, gas, groceries, utilities, etc. Of course, 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 than the three-times-rent income guideline 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 one third of your gross income to rent does not leave a lot of extra money 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 from house to house and person to person, depending on your personal energy usage habits.

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 created the mortgage mess we are dealing with today.

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 debt ratio as high as 60 to 70 percent.

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

That’s why lenders have now tightened their underwriting standards so that today many will not qualify mortgage borrowers above 45 percent ratio. But even that is still very high compared to the underwriting standards of 10-15 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 a third, or 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.

Mail your real estate questions to Steve Tytler, The Herald, P.O. Box, Everett, WA 98206, or e-mail him at economy@heraldnet.com.