Housing's 30-Percent-of-Income Rule Is Nearly Useless

The enduring rule of thumb is arbitrary and almost meaningless in today’s market
“Thou shalt not commit more than 30 percent of thine income to housing” Photograph by Gene Lester/Getty Images

When you’re looking for a place to live, one number rules your world: You should spend no more than 30 percent of your income on housing. You may hear that rule of thumb from a financial adviser or parent, a landlord or lender. It’s embedded in online budget calculators and federal policies. There’s just one problem: “It’s essentially an arbitrary number,” says David Bieri, an assistant professor at the University of Michigan. “It creates more distortions than it actually solves.”

If the 30 percent rule ever made sense—which economists contest—it’s almost meaningless now, when almost 41 million U.S. households spend more. Income growth has been tepid, yet home prices are rising and rents have soared, threatening to make cities from Austin to New York unaffordable for average earners. In San Francisco, any available reasonably priced housing quickly disappears. “It’s not just techies fighting over $5,000 apartments,” says Matt Schwartz, chief executive officer of the nonprofit California Housing Partnership. “The competition at the bottom end is fierce.”

The ratio’s roots date to 1969, when Edward Brooke (R-Mass.), the first black senator elected since Reconstruction, pushed through a law to help the poorest of the poor afford shelter. The Brooke Amendment, as it became known, capped rent in public housing at 25 percent of residents’ income. Former Representative Barney Frank (D-Mass.) later called it “one of the greatest acts of compassion ever to pass this body.” Facing a budget crunch in 1981, Congress raised the rent ceiling to 30 percent, and it’s held there ever since. Mortgage giants Fannie Mae and Freddie Mac apply a 28 percent cutoff for home loans they buy from lenders.

Even before the Brooke Amendment became law, economists said the ratio oversimplified the affordability question. In the intervening decades, many have come to favor what’s known as the “residual income” approach, which focuses on whether a family can afford other basic necessities after paying for housing. “If your income is $500,000 a year, you can pay 40 percent and still have money left,” says Frank Nothaft, the chief economist at Freddie Mac. “But if your income is $20,000 a year, it will be hard to make ends meet if you’re paying 30 percent of your income on rent.”

Michael Stone, a professor at the University of Massachusetts at Boston who has studied the issue since the 1970s, coined the term “shelter poverty” to describe the condition of people who spend so much on housing that they have to cut back on other necessities, such as food and health care. Stone found that the total number of households paying too much for housing according to the 30 percent ratio is roughly the same as under the residual income approach, but the composition of the groups is different. Families with two incomes and no children can spend more on housing than those with kids, which have to pay more for everything from clothes to day care.

Stone wrote in a 2006 paper that using the residual income approach reveals how “affordability problems for families with children are rather more severe than usually thought.” He proposed that government programs for first-time home buyers provide borrowers with a residual income calculation to help them avoid getting in over their heads. That proposal, made just before the housing market peaked, hasn’t been implemented.

Federal rent subsidies keep housing costs to 30 percent of income, which has an unintended effect, Bieri says: It encourages people to live in cities where housing costs are higher and the quality of life is better. “We should account for the fact that in New York, when you pay for housing you are not only paying for the cost of shelter, you are also paying for access to jobs” and amenities, he says. Bieri is trying to develop a subsidy formula that would account for the extra costs associated with living in desirable cities. “The last thing you should do is subsidize those places,” he says; instead, the government should focus the limited funds earmarked for housing aid on struggling regions.

For many families, getting to and from work is the second-largest monthly expense, one that’s directly tied to where they live. A house in a far-out suburb may look cheap, but add in gas for an hour-long commute and the cost rises considerably. Developers are increasingly building high-end housing near public transit, which in some cases pushes lower-income families to less convenient locations.

In November, the Department of Transportation and the Department of Housing and Urban Development released a new “location affordability index” that shows how housing and transportation costs compare with income in almost 200,000 neighborhoods. And in June, California’s legislature approved using $65 million to develop affordable housing near transit hubs. An analysis by the California Housing Partnership, which lobbied for the funding, found that building affordable housing close to transit would allow one of every two low-income households to dispense with a car, a major savings.

Coming up with a practical alternative to the 30 percent rule isn’t easy, because many factors influence affordability. The statistical model behind HUD’s location affordability index is the result of almost a decade of research and includes 30 variables. Stone has proposed putting affordability standards on a sliding scale that accounts for other measures such as location, family size, and income. The 30 percent rule’s simplicity may be why it has endured despite decades of criticism. It makes it easy to compare locations and measure housing trends over time. At best, Bieri says, the rule is a “moist-digit indicator,” as in “lick your finger, stick it in the air, and see where the wind is blowing.”