In Terms of Mortgages, What Does the 28/36 Rule of Thumb Mean?

In Terms of Mortgages, What Does the 28/36 Rule of Thumb Mean?

Find out how much of a mortgage you can comfortably pay.

Homebuyers can prevent themselves from overextending their financial resources by following the 28/36 rule of thumb, which is a mortgage benchmark based on debt-to-income (DTI) ratios. This rule is what mortgage lenders use to determine whether or not they will approve your application for a mortgage.

This article will explain how the 28/36 rule of thumb works, as well as what it takes into account and what it leaves out, along with some computations as examples and some cautions regarding the use of the rule.

Key Takeaways

  • The “28/36 rule of thumb for mortgages” is a tool for determining how much house you can afford to purchase without feeling financially strained.
  • The DTI ratio of 28/36 is calculated using your gross income, so it may not take into account all of your outgoing cash.
  • According to the rule, housing costs should not exceed 28 percent of your gross monthly income, and debt payments, including housing costs, should not exceed 36 percent of your income.
  • Some mortgage lenders will spend a greater proportion of a borrower’s monthly income on debt than others.
  • One strategy to reduce your overall DTI is to pay off some of the balances you have on your credit cards.

In terms of mortgages, what does the 28/36 Rule of Thumb mean?

Your debt-to-income ratio, often known as your DTI, is a common gauge that mortgage lenders use to establish the maximum amount of money they will allow you to borrow from them. The 28/36 rule is a rule of thumb that is commonly used for DTI.

 The 28/36 rule simply states that a mortgage borrower or household should not use more than 28 percent of their gross monthly income toward housing expenses and no more than 36 percent of their gross monthly income for all debt services, including housing, “Marc Edelstein,” a senior loan officer at Ross Mortgage Corporation in Detroit, told The Balance via email. Edelstein works for Ross Mortgage Corporation in Detroit. “The rule simply states that a mortgage borrower/household should not use more than 28 percent of their gross monthly income toward housing expenses.”

It is essential to have a thorough understanding of what housing expenses include because they consist of a greater variety of components than simply the raw sum that constitutes your regular mortgage payment. Your housing costs may include the principal and interest that you pay on your mortgage each month, as well as fees charged by your housing association, homeowners’ insurance, and possibly even more.

Determine the amount of your payment each month.

The purchase price of your home; the amount you put down as a down payment; the length of the loan; the interest rate on the loan; property taxes; and homeowners insurance all play a role in determining your monthly mortgage payment (which is highly dependent on your credit score). Make use of the following inputs to get a general idea of what your monthly mortgage payment might turn out to be.

 How exactly does one use the 28/36 Rule of Thumb?

How exactly does the 28/36 rule of thumb come into play when it comes to mortgage lenders deciding how much money to offer you?

 Let’s imagine that you have a monthly income of $6,000 before taking into account any deductions for taxes or other expenses. According to a common piece of advice, your monthly mortgage payment shouldn’t be more than $1,680 ($6,000 multiplied by 28 percent), and the sum of all of your monthly debt payments, including housing, shouldn’t be more than $2,160 ($6,000 multiplied by 36 percent). 

Andrina Valdes, COO of Cornerstone Home Lending in San Antonio, told The Balance in an email that a mortgage lender may use this guideline “to judge or forecast that you will be able to take on a given monthly mortgage payment for the foreseeable future.” The 28/36 rule provides an answer to the issue, “How much house are you able to buy with your current income?”

 The rule of thumb should be something that you calculate before you start browsing for homes, as it offers you an exact indication of how many houses you can afford to buy at one time.

A Guide to Figuring Out Your Debt-to-Income Ratio

The ratio of your debt to your income is not difficult to calculate. The first thing you need to do is calculate your monthly gross income, which is your revenue before any deductions are made for things like taxes and other expenses. It is important to consider both of your salaries when applying for a home loan, even if you are married and planning to apply for the loan together.

After that, take the amount and multiply it by 0.28, then by 0.36, and finally by 0.43 if you’re trying to get a mortgage that meets certain requirements. For instance, if you and your significant other have a joint monthly gross income of $7,000, it would be split down as follows: 1

  • $7,000 x 0.28 = $1,960
  • $7,000 x 0.36 = $2,520
  • $7,000 x 0.43 = $3,010

This indicates that your monthly payments for your mortgage, taxes, and insurance shouldn’t be more than $1,960, and the total amount you should be paying toward your debt each month, including that $1,960, shouldn’t be more than $2,520.

Unfortunately, the rule requires that you maintain your monthly payments at a level that is lower than both of these thresholds. Therefore, the following step is to determine the impact that your other loans have. Add up all of your other monthly debt payments that aren’t for your mortgages, such as those for your credit cards, student loans, and auto loans.

 For the purpose of this illustration, let’s say that your monthly debt payments come to a total of $950. If you take that number and deduct it from $2,520, you’ll see that your monthly mortgage payment shouldn’t be more than $1,570.

 You are restricted to paying no more than $1,570 on a new home’s mortgage, property taxes, and homeowner’s insurance due to the fact that you have a reasonably large monthly debt payment that is not for the mortgage. Because $1,960 plus $500 equals $2,460, which is less than the rule of 36 percent, which is $2,520 for all debt payments per month, you would be able to spend the full $1,960 on your mortgage payment in this scenario. On the other hand, if you only had $500 in monthly debt payments that were not related to your mortgage, you would be able to spend the full amount.

Reasons Why the 28/36 Rule of Thumb Is Commonly Accurate

The 28–36 rule of thumb is a reasonably reasonable benchmark for lenders to follow when determining how much of a mortgage payment a customer can afford.

 Edelstein explained that one of their responsibilities as mortgage lenders is to evaluate risk, and the 28/36 rule plays a significant role in this process. “You may be eligible for a mortgage even if your ratios are greater than 28/36, and even if they are as high as 50 percent on the back end.” But the risk goes up, so you’ll need a good credit score and maybe a bigger down payment to be approved for a higher ratio.

What factors into the calculation of your monthly debt obligations are taken into account by the DTI ratio? Your debt-to-income ratio (DTI) may take into account any of the following payments:

  • Future mortgage payments
  • Cards that grant credit
  • Student loans
  • Auto loans
  • Personal loans
  • Payments are made for alimony and child support.
  • On loans that you are a co-signer on
  • Your DTI doesn’t cover electricity, cable, cellphone, and insurance payments.

A Particle of Salt

The 28/36 rule of thumb is a good guideline for many borrowers, but it does have several flaws that make it less than ideal.

For instance, DTI does not take into consideration costs associated with maintaining a household, such as the cost of electricity, groceries, or child care. It is possible that homebuyers will underestimate their genuine DTI as a result of this. It is important not to overlook the cost of home maintenance and repairs, which, according to Edelstein, can amount to an average of one to two percent of the value of the home each year.

In light of these added costs, Edelstein recommended that prospective homeowners aim for a DTI that is lower than the maximum of 43 percent that is used by the majority of lenders, which is what the 28/36 rule of thumb does. Because of this, you will have a lower percentage of your monthly debt payments committed to your mortgage, which means you will have a greater chance of living the lifestyle you want to live. 

Because of this, would-be borrowers can’t just assume that the fact that their mortgage application was approved means they’ll be able to pay the mortgage in the long run just because their application was approved.

Borrowers with high DTIs, according to the Consumer Financial Protection Bureau (CFPB), “are more likely to run into difficulties paying monthly payments.”

How to make more money in relation to your debt so that you can get a mortgage

Before you apply for a mortgage, you should look for strategies to lower your DTI so that you will feel more comfortable with your monthly payments.

According to Valdes, one way to reduce your DTI is to pay down your credit card bills and then make it a point to ensure that those balances never exceed 30% of your total credit limit.

“It’s… beneficial to come up with a strategy to pay down debt — like the debt snowball method, where you attack your smaller debts one at a time while making minimum payments on the others,” she added. It’s good to come up with a plan to pay down debt. “Creating a budget and making cuts, where they are needed, can help free up extra income that can be used to pay off debt; paying off little debts one at a time makes a huge difference.”

Another useful piece of advice is to stagger the submission of your loan applications. For instance, Edelstein advised against applying for a mortgage at the same time as you apply for other types of credit, such as a new car loan or lease, because the new credit could lower your credit score and raise your DTI. You should also not apply for a credit card at the same time you apply for a mortgage.

Before you apply for a mortgage, here are some more things you may do to improve your debt-to-income ratio:

Pay down the balance on the credit card with the highest interest rate first, or pay equal amounts toward all of your credit card accounts.

If you want to merge multiple obligations into one with a single interest rate, you may think about getting a loan to consolidate your debts.

When you are in the process of applying for a mortgage and up until the point where you have successfully closed on a house purchase, you should refrain from taking on any new debt.

Think about methods that you may use to boost the income of your household, such as asking for a pay increase, getting part-time work, beginning a side business, or looking for a higher-earning position with a different employer.

Questions That Are Typically Asked (FAQs)

What exactly are closing costs, and how much do they typically cost?

The many expenses that must be paid for in order for you to legally acquire a home are referred to collectively as “closing fees.” Closing costs should range between 3% and 5% of the total purchase price of your home.These charges can include things like fees for the title, an appraisal, taxes, and recording fees. 5

I have a DTI of 50%; am I qualified for a mortgage?

It is possible, but not certain, that you will have trouble finding a mortgage lender willing to work with you if your DTI is fifty percent or more. In other words, if the borrower has six months’ worth of payments saved up in addition to other qualifying circumstances, the government-sponsored mortgage finance company Fannie Mae will approve a DTI of “above 45 percent” on a case-by-case basis. This provision is made possible by Fannie Mae. 6

What does it mean when a rule refers to “capacity to repay?”

Mortgage lenders have a responsibility to perform what is known as “due diligence” in order to ensure that borrowers will be able to pay back their loans. For example, if a mortgage’s interest rate is expected to go up in a few years, it is the lender’s job to make sure that the mortgage can still be paid off even with the higher rate.

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