The 28/36 rule of thumb is a mortgage benchmark based on debt-to-income (DTI) ratios that homebuyers can use to avoid overextending their finances. Mortgage lenders use this rule to decide if they’ll approve your mortgage application. When mortgage lenders are trying to determine how much they’ll let you borrow, your debt-to-income ratio (DTI) is a standard barometer.
The 28/36 rule simply states that a mortgage borrower/household should not use more than 28% of their gross monthly income toward housing expenses and no more than 36% of gross monthly income for all debt services, including housing. It’s important to understand what housing expenses entail because they include more than just the raw number that makes up your monthly mortgage payment. Your housing expenses could include the principal and interest you pay on your mortgage, homeowners insurance, housing association fees, and more.
Here are a few ways to improve your DTI before applying for a mortgage:
Pay down your highest balance credit card, or pay smaller amounts to all of your credit card accounts.
Consider a debt consolidation loan to combine credit cards or other debts at a single interest rate.
Avoid incurring new debt during the window of time leading up to applying for a mortgage and before you’ve closed on a home.
Consider ways you could increase your household income, such as negotiating a raise, taking on a part-time job, starting a side hustle, or seeking a higher-paying role with a different employer.
The 28/36 rule is a guide that helps mortgage lenders determine how large a mortgage they can afford. It’s based on two calculations: a front-end and a back-end ratio. Here’s how it works.
Let’s start with the first half of the rule, which is that a household should spend no more than 28% of its gross monthly income on housing expenses. This is called the “front-end ratio.”The front-end ratio does not include other housing expenses like utility bills or cable TV services. If a borrower expects to pay $1,100 in monthly principal and interest, plus $300 in property taxes and homeowners insurance payments, the PITI costs would be $1,400 per month. Thus, the household must have gross monthly income (pre-tax income) of at least $5,000 per month ($1,400 / $5,000 = 28%) to qualify on the front-end ratio.
The second half of the rule is the back-end ratio. This ratio is calculated by dividing all recurring monthly payments on the debt by a household’s gross monthly income. The back-end ratio includes all debt: PITI payments on your mortgage, any homeowners-association dues or condo fees, and credit cards, car loans, student loans, and other personal loans. Where applicable, the back-end ratio also includes required monthly child support or alimony payments. A past divorce can come back to haunt a borrower when it comes time to apply for a mortgage. It is to ensure the monthly payments are only included in the back-end ratio when they are expected to be paid for the next 10 months or more. For example, A car loan with 12 remaining monthly payments would be included, but a car loan with only nine payments remaining would not be. Paying down your other loans can be a really good way to qualify for a larger mortgage. Although some lenders are willing to stretch on terms, these loans are riskier for the borrower and lender alike. Borrowers who can qualify under the 28/36 rule shouldn’t have much difficulty repaying their loans. If one or both ratios exceed the percentages allowed under the 28/36 rule, you would need to take action to bring the ratios within the limits. You might reduce the mortgage loan amount with a larger down payment or consider another type of loan with a smaller payment. If you fail to meet only the back-end ratio, you might pay down some of your debts to reduce your other monthly debt payments. The 28/36 rule benefits both the lender and the borrower. All lenders, including mortgage lenders for poor credit, want to lend money to someone who earns more than enough to make the mortgage payments and cover all their other monthly obligations.
According to lenders, the 28 36 Rule ensures to keep the borrowing capacity of an individual always in check. Any borrower who follows this rule will be less likely to default when it comes to paying the credit card dues or Loan EMIs. The importance of this rule increases in the case of Home Loans as these loans are usually high-ticket purchases and taken for a long period. This rule also decides whether you will be able to get a home loan or not.
The 28/36 rule gives you a sense of how much you can afford to spend without stretching your finances to the breaking point. Whether you’ve purchased a dozen homes over your lifetime or you’re working with a lender that specializes in mortgages for first-time home buyers, the ratio helps protect both you and the lender.
According to the rule, you should only spend 28% or less of your gross monthly income on housing expenses. You should also only spend 36% of your gross monthly income on all your debts, from credit cards to car loans to child support. Most responsible lenders follow a 36 percent back-end DTI ratio model unless there are compensating factors.
To qualify for a mortgage, the borrower often must have a front-end debt-to-income ratio of less than an indicated level. Paying bills on time, a stable income, and a good credit score won’t necessarily qualify you for a mortgage loan. In the mortgage lending world, how far you are from financial ruin is measured by your DTI. Simply put, this is a comparison of your housing expenses and your monthly debt obligations versus how much you earn.
According to the rule, you should spend no more than 28 percent of your gross monthly income on housing costs. In addition, no more than 36 percent of what you make should go toward debts. Lenders look to the 28/36 rule when assessing whether or not a borrower has the ability to afford a mortgage. Here’s what you need to know if you’re in need of financing to buy a home. The idea behind the 28/36 mortgage rule is that it can be used to determine an applicant’s financial health and how much debt they can safely take on. Anyone who doesn’t fall within the parameters of the rule is thought to be more likely to default on a loan. Some lenders may relax the requirements for those with high credit scores, but you can’t count on that happening.
Lenders usually prefer a front-end DTI of no more than 28%. In reality, depending on your credit score, savings, and down payment, lenders may accept higher ratios, although it depends on the type of mortgage loan. However, the back-end DTI is actually considered more important by many financial professionals for mortgage loan applications. When preparing for a mortgage application, the most obvious of strategies for lowering the front-end DTI is to pay off debt. However, most people don’t have the money to do so when they are in the process of getting a mortgage, most of their savings are going toward the down payment and closing costs.
The 28/36 rule can come in handy during the early planning stages of getting a mortgage loan. There are many different factors that come into play when determining if an individual can afford a particular loan, including credit scores and length of employment. Using the 28/36 rule helps to narrow down an affordable range for your actual loan payment so that you are not overwhelmed with more expensive choices. If you want a bigger, more expensive house, you will know how much debt you will need to pay off before you try to buy one. If you are comfortable with the price level you can afford, then you are good to go.