How Much Can I Afford?

1) Purchasing a Home

I purchased my first home a little over a year ago, and it was the best and most overwhelming thing I have ever done. When calculating what you can afford for a new home, be sure to use PITI (Principal, Interest, Taxes and Insurance) as the monthly expense—not just the principal and interest payments.

Real estate taxes and home owners insurance are often escrowed into the monthly payment with your principal and interest payments for your mortgage.

PITI should remain lower than 28 percent of your gross income. (Gross income is your top line salary before taxes, insurance and retirement savings.)

2) Renting a Home

Benchmark: Keep rent under 33 percent of take-home pay.

Okay, so you’re not quite ready to purchase a home or you can see yourself moving to a new city within the next couple years. Renting is more likely a better option for you. In general, your monthly rent should not be greater than one third of your monthly take-home pay.

While that may seem low, considering your residence is most likely the largest expense you will have each month, you will want to have ample money left to pay for utilities, gas, groceries and entertainment expenses. I doubt many people would enjoy living in a luxurious apartment if they can’t pay for the internet and Netflix or go out to dinner with friends.

3) Purchasing a New Car

Benchmark: Keep expenses under 20 percent of take-home pay.

One of the first major purchases people make on their own is a car. Whether it’s after landing that first real job or getting a promotion they’ve been vying for the past two years, people tend to reward themselves with a shiny new ride. And there is nothing wrong with that… as long as you are rational about the car you pick.

Unless you pay with cash, purchasing a car comes with monthly car payments. As a rule of thumb, you should not be paying more that 20 percent of your take-home pay on car related expenses. Generally you it should be much less than 20 percent if possible.

Don’t forget that owning a car comes with many other expenses: insurance, maintenance, gas, etc. Be sure to take those things into consideration when shopping for your next car.

4) Credit Card Balance

Benchmark: Pay off in full each month.

To me, this answer is the easiest. Ideally, you should be able to pay off your entire credit card balance each month without eating into savings. That means you can afford to charge an amount equal to what is left in your checking account after paying your bills and contributing to retirement savings—something everyone should be doing. Creating a reverse budget can help you hit your savings goals and have a reasonable spending target.

If you are able to pay off your credit card balance after paying bills and saving money for a rainy day and/or retirement, then you are living within your means and can afford your credit card bill.

Remember: These benchmarks are for the standard household. If you plan to spend 50 percent of your income in any given year on traveling or paying off student loan debt, you will want deduct the amount you plan to dedicate to those other expenses from your total take-home income. Then, use the benchmarks to calculate what you can afford.

5) Savings

Benchmark: Save 10 percent for basics, 15 for comfort and 20 (or more) to escape.

The final benchmark I will leave you with is the percent of your income you should save. The old adage reads: Save 10 percent for basics; 15 percent for comfort; 20 percent to escape.

Make sure you are building retirement and emergency fund savings into your budget when calculating the amount you can afford to spend on any large purchases.

See, it really isn’t a simple answer! However, with a little math, you can feel more confident in the financial decisions you make.