The 28/36 rule is well known in the mortgage industry as a requirement that determines the amount of debt that you can accumulate, while still being eligible for a non-government backed mortgage loan.
According to the rule, no more than 28% of your gross income each month should be spent on covering housing costs. In addition, the maximum amount that you should spend on your total debts, including vehicle loans or credit cards, should not exceed more than 36% of your gross income.
When going through the approval process for a conforming mortgage, or one that is outside of typical government funding, you may run into issues under two main circumstances. Accepting a mortgage loan would require you to pay over 28% of your households gross wages on housing costs, or your total debts including your mortgage payment would cause you to spend over 36% of your gross monthly income.
What is the 28% Front-End Ratio ?
The 28% front-end ratio is a term often used by lenders to indicate the amount of your housing expenses each month when compared to your gross income each month. The rule states that the ratio should be no more than 28% but less is ideal.
When it comes to using the front-end ratio there are some factors to take into consideration when determining your true housing costs:
- Homeowner’s Insurance – This type of insurance is required to protect your home in the event of a catastrophic event such as a flood, hurricane, or other natural disaster.Â
- Homeowners’s Association Fees (HOA) – These due are required if you reside in a community that has a homeowners association and charges fees on a monthly basis.
- Property Taxes – Taxes for your property are based on the home’s value as well as what state your home is located in.
- Principal Amount – The principal is the original amount that you borrow for your mortgage loan.
- Mortgage Interest – The mortgage interest is the amount of money, usually a percentage of the principal amount, that is charged by the lender for loaning you money to purchase a home. Payments are divided on a monthly basis.
Lenders don’t typically factor in costs such as lawn care, utilities, or other extra costs when calculating your ratio for mortgage approval.
What is the 36% Back-End Ratio?
The 36% back-end ratio is also known in lending circles as the debt-to-income ratio. This amount is based on the total debts you are paying each month versus your monthly income after taxes, or gross amount.
Lenders will look carefully at this percentage even if your housing costs are below the front-end ratio due to the fact that additional debts could cause you to be over the threshold. In this scenario you would be considered a high risk borrower, since your total debts could put you over a 36% back-end or DTI ratio.
When considering what items go into this calculation, it is important to look at all debts including student loans,child support, personal loans, credit cards, alimony payments, and any other debt obligations that will have a major impact on your outgoing expenses.
An Example of a Budget Using the 28/36 Rule
Budgeting with the 28/36 rule takes into account a series of factors when determining the percentage of household expenses and debts in correlation to your monthly income. A family with a proper mortgage approval ratio would have moderate housing costs, with additional debts totaling between 7% to 10% of their monthly income.
An example would be a family that brings in $6,000 per month after taxes, with additional debts including a $250 student loan, $200 in credit cards, and a $150 vehicle loan payment each month. Since the housing costs would fall under the required threshold, then the family would have enough room to cover at least 7% of other debts in order to retain the financial stability needed for a home loan.
| Household Budget | Expense Ratio | Debt Ratio |
|---|---|---|
| Gross Monthly Income | $6,000 | $6,000 |
| Housing Expenses | $1500 (25%) | (25%) |
| Credit Card Payment | $200 (3%) | (3%) |
| Vehicle Loan Payment | $150 (0.25%) | (0.25%) |
| Student Loan Payment | $250 (4%) | (4%) |
| Total Monthly Obligations | $2,100 (35%) | (35%) |
Common Exceptions to the 28/36 Rule
There are some situations where exceptions can be made to the rule, however these are on a case by case basis and may consist of very few financial situations.
Lenders have been known to approve loan applications for borrowers who exceed the amount but have an above average or excellent credit score, usually ranging between 700 and 800.
Borrowers who can provide an additional down payment of at least 20% can also gain approval when the debt-to-income ratio is slightly higher.
In addition, those who are seeking a non-conforming loan such as those offered by the United States Department of Agriculture, Federal Housing Association, or Veterans Administration may qualify with a higher ration based on additional approval factors as a result of government backing.
Conclusion
Applying for a home loan isn’t as simple as filling out an application. There are many factors to consider when it comes to your income, debts, and other obligations. If you aren’t sure whether or not you may qualify for approval, then the 28/36 rule may provide you some insight into your financial picture and how fitting a mortgage into your budget is right for you.
