50% Rule & Taxes and Insurance

6 Replies

The 50% rule (or guideline) says you should not exceed 50% of your gross income in debt service.I.e. Principle and interest payment every month. Example, your gross rental income for the month is $1,000.00.Therefore your total loan payment should be $500 or less.Thus, leaving the other $500 for potential operating expenses.The leftover is your profit to do as you see fit.

I've often seen that insurance and property tax are considered "operating expenses" in the 50% rule.And not part of the debt service side.Insurance and property tax are two items are items that you obliviously going to need to pay.

In my last property purchase, the loan payment is clocking in at 43%, taxes are taking 12.7% and Insurance at 5.15% of my gross rental income.So while I'm under the 50% rule for just debt, I'm at 61% in required monthly payouts in principle, interest, insurance and taxes or PIIT.( I pay the taxes myself not the lender.)

My question is, what's other investors opinion?Do you consider insurance and property tax "operating expenses" or do you lump them in on the 50% side of the principle and interest mortgage or loan payments.Thanks!

Taxes and insurance are part of life. You can include them either side of the 50% which is just a guideline. Either way 60 percent is acceptable for expenses as long as 40% will work for your maintenance and profit. You are the one who looks at the actual numbers and has to decide what your comfortable with in the end.

I've always considered taxes and insurance as operating expenses since they are expenses that are pretty much guaranteed.

@Charles Press  The 50% rule has nothing to do with financing. The 50% rule applies whether you pay all cash or choose to finance a property. 

The 50% rule says your operating expenses (including taxes and insurance - but NOT including financing) will over a portfolio of houses generally average about 50% over time. 

This means you have 50% left to cover your financing costs and profit.

50% is a generalization. It is a rule of thumb but it is a good rule of thumb backed by lots of data.

If you have actual numbers that say the expenses will be higher than 50% go with the actual numbers. Otherwise assume 50%. Even if you have actual numbers which are less than 50%, that is not something you can count on over time - assume the 50% number

Medium crab1 copyNed Carey, Crab Properties LLC | http://baltimorerealestateinvestingblog.com/

Ned,

Thanks for the clarification.  I was looking at it from the other side.  Not having your financing costs exceed 50%.  In order to be able to cover operating expenses.  See what you mean though.  Assume operating expenses will come out to 50% in the long run.  Then that leaves 50% for debt service and profit.   Thanks!  

@Charles Press taxes and insurance are operating expenses and hopefully all your expenses don't exceed 50%. With some properties with lower rents and higher taxes, the tax portion can skew the operating side. In addition if you are working with a lower rent then the cost of a roof can still be 5k which will throw things off for years too.

The 50% rule includes long-term cap ex. With the low cost housing you would be better off separating these things and figure your actual operating and make your own projections for cap ex IMO.