It's generally accepted that 30 to 35% is about right for housing expenses. That would include rent, plus utilities, any maintenance and decorating.
Some would argue that Michael could spend up to 40% for housing. The trouble with that is Michael has a limited amount of money. His paycheck needs to cover housing, automobile (or transportation), food, insurance, entertainment, clothing, medical/dental, miscellaneous and debt repayment. So an increase in housing expense means a decrease somewhere else.
Michael didn't share what his income is. So we'll have to keep this somewhat general. But, we'll still be able to illustrate the point.
The three biggest expenses he'll face are housing, transportation and food. Along with 30% for housing, he'll probably need another 15% each for transportation and food. So he's already spent 60% of his money leaving just 40% for everything else.
The quickest way for a budget to fail is to overspend these 'big three' categories. If Michael spends 65 or 70% it becomes almost impossible to make up the difference in the smaller categories. Even if he cuts back drastically in areas like entertainment and clothing, he just won't find enough savings to offset the additional expense.
Overspending in these big areas is also a problem because we often make commitments for months or even years in advance. It's not like your electric bill. If it was too high last month, you can start turning down the AC today. But, if you agreed to make forty eight auto payments, there's not much you can do about it for awhile. Or, if you do make a change, it will significantly disrupt your lifestyle.
Let's suppose that Michael's take home pay was $2,000 per month. He really wanted an apartment that cost $800 (40% of his income). Add his car payment ($225), gasoline ($75), groceries ($150) and restaurant meals ($150). That totals $1,400 and only leaves him $600 to cover debt repayment, clothing, entertainment, medical, miscellaneous, savings and any unexpected bills. Chances are that he'll quickly be putting some of those expenses on his credit card and adding to the unpaid balance. At some future point that will come back to haunt him.
If Michael were making a lot more he'd have more flexibility. If his monthly income were $10,000, it wouldn't make as much difference if he spent 35 or even 40% of his income on housing. He'd have more in other categories to make up the difference.
Most of us live with limited income. It's important for us to get our housing, auto and food expenses under 60% of our take home pay if we're going to keep from getting into financial trouble.
I think it is important to note that the average percentage of 30% is more important to those with less money than those with more money. This is particularly important when considering young people who are not as likely to get jobs that pay as much as those who have more experience.
I went to bankrate.com, where I found a calculator that allowed you to compare various costs in certain cities, including average rent and utilities. I added these figures and multiplied by 12 to get the yearly expenditures on housing. Then I multiplied to get the net salary that would be necessary to maintain the recommended 30% of net salary for housing.
I then went to the Bureau of Economic Analysis, where I found a list of Average Wage per Job for many cities. I used the most recent data: 2006. Since these figures were gross wages, I went to a paycheck calculator at paycheckcity.com to figure out what the average take-home pay would be in each of these cities. (This calculator was great because it took into consideration what state the money was being made in and also could calculate according to 2006 tax rates.)
Finally, I did two calculations:
1. The difference between the average net salary for a city and the net salary needed to maintain the 30% ratio. A negative number meant that you were spending that many dollars more than the 30% recommended amount.
2. The percentage of the average net salary that the average rent actually represented.
Be aware that if you live in a city where a car is unnecessary, you will have more income available to cover housing costs. That was something I couldn't factor in, but you can in your own situation.
Rather than try to figure out how to format all those results on this blog, I have published this data to Google docs. While I will discuss my own take on the ramifications of this data in the coming days, I'd be very interested to hear initial reactions from my readers. If there is a city that isn't in the current table that you'd like included, let me know -- the major one that is missing is Minneapolis, which is due to the fact that the cost of living comparison calculator for some reason didn't include Minneapolis. But I'll give a look for others, if you're curious.