Before you commit to a mortgage, consider the 28/36 rule to make sure you’re not getting in over your head. How does the rule work? It’s a common-sense way of measuring your debt load before you apply, and most lenders already use it to approve loans, so you might as well run the numbers to see how you stack up. Here’s how it works.
What is the 28/36 Rule?
Perhaps you’ve heard the phrase “house poor”? It describes the phenomenon in which a homeowner puts all of their financing and cash into home ownership―to the point that they can’t cover other expenses, like unexpected repairs or healthcare costs. Of course, this can put homeowners at risk of defaulting on their mortgages. To avoid this, lenders like to see two specific ratios of debt to income, known as the 28/36 rule, which breaks down as follows:
Your total property expenses shouldn’t exceed 28 percent of your gross monthly income. Known as the “front-end ratio,” this covers housing expenses including the mortgage, property taxes, mortgage insurance, and homeowner association dues (although utilities aren’t included, for some reason). To know if your front-end ratio exceeds 28%, add up all your housing expenses (or potential housing expenses), and divide the total by your gross monthly income. Then, multiply that number by 100 to get your front-end ratio.
Your total household debt―including your property expenses―shouldn’t exceed more than 36 percent of your gross monthly income. Known as your “debt-to-income” or “back-end” ratio, this covers credit cards, student loans, personal loans, auto loans, alimony, child support and utility bills. To know if your back-end ratio exceeds 36%, add all of your monthly housing and consumer debt, and divide the total by your gross monthly income. Then, multiply that number by 100 to get your back-end ratio.
What if my debt exceeds the 28/36 threshold?
Not all is lost. You can still qualify for loans if you have excellent credit, and, as Insider points out, government-backed FHA, VA, or USDA loans will approve ratios that are slightly higher.
That said, be aware that applying for a mortgage will result in a hard pull on your credit, which can temporarily hurt your credit score. For that reason, you’ll want to run the numbers before you apply for a mortgage, as it’ll give you an idea of whether you qualify, without the hard credit check. If you don’t qualify, financial experts recommend holding off on buying a home until you have more income or a bigger down payment.