Recommended Percentage of Income for Housing

The need to invest in home renovation may dictate a lower housing-to-income ratio.
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Banks, parents and financial advisers often have general guidelines for what percentage of income you should put toward housing. A 30 percent-of-income rule of thumb has existed since a 1981 act of Congress raised the cap for renters to contribute 30 percent of their income to public housing rentals. However, the best ratio of housing to income depends on what you earn, what you owe and what percent of your income is discretionary.

The 30 Percent Rule

The 30 percent rule was actually the 25 percent rule when Congress first enacted a law in 1969 to cap public housing rental fees at 25 percent of renters' income, according to a July 2014 "Bloomberg Business" article. Over time, the 30 percent rental cap has been analyzed as a general guideline to housing spending. "Bloomberg Business" reported that 35.3 percent of Americans exceeded the 30 percent ratio thresholds in 2012, and about 20 percent spent more than 50 percent of their income on housing.

Mortgage Lender Ratio

Conventional mortgage lenders use a 36 percent mortgage-to-income ratio limit as a guideline when evaluating applications, according to a May 2014 column by financial expert Dave Ramsey for Fox Business. In this ratio, your potential mortgage payment, interest, tax installments and insurance -- abbreviated as PITI -- are all considered in the mortgage or housing costs. If your gross monthly income is $5,000, for instance, your maximum PITI payment shouldn't exceed $1,800. While this is a general guideline, lenders may consider higher ratios based on other financial information in the application. Ramsey, who advises a 25 percent-of-income rule for housing expenses, believes 36 percent is too much for most borrowers.

Rent vs. Mortgage Comparisons

While the 30 percent rule is more often associated with rentals, and the 36 percent mortgage-to-income ratio ties to home loans, these percentages offer general guidelines for housing expenses. There are some differences in renting versus borrowing that may affect a safe ratio. Renting, especially with a short-term lease, is typically not as high risk as taking out a long-term mortgage. If you can't meet rental payments, you risk eviction and negative credit score impacts. With a mortgage default, you not only risk losing your home and suffering significant credit rating problems, but you also risk losing your investment in the property. Being tied down with a hefty mortgage-to-income ratio limits your quality of life, reports Ramsey.

Personal Factors to Consider

General rules like the 30 percent or 36 percent guidelines are cookie-cutter approaches. Each renter or borrower has his own financial situation to consider. Someone with significant savings is in a safer position to extend himself on a home loan than someone living paycheck to paycheck and carrying sizable debt. You also need to consider your financial goals. If you want money for a kids' college fund, family vacations or early retirement, a lower housing percentage is advisable. Some people also pay alimony or child support or make regular charitable contributions, which aren't normally factored into the typical budget with a housing ratio guideline.

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