What Is The 28/36 Rule For Home Affordability?

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“How much house can I afford?” That’s the first question prospective homebuyers should ask themselves. While you may have an idea of how much of a monthly mortgage payment is, mortgage lenders have a formula they use: the 28/36 rule. Let’s get into what this rule is and what it means for you.

What is the 28/36 rule?

This rule of thumb dictates that you spend no more than 28% of your gross monthly income on housing costs, and no more than 36% on all of your debt combined, including those housing costs. Housing costs encompass what you may hear called by the acronym PITI: principal, interest, taxes and insurance. These are the main components of a homeowner’s monthly mortgage payment.

The 28/36 rule reflects what’s known as the front-end and back-end ratios on a mortgage:

• Front-end ratio (28%): The maximum percentage of gross monthly income you should spend on housing.
• Back-end ratio (36%): The maximum percentage of gross monthly income you should spend on all of your debt, including housing. This is also known as your DTI, or debt-to-income ratio.

While it’s commonly called a “rule,” 28/36 is not a law, just a guideline. Mortgage lenders use it to determine how much house you can afford if you were to take out a conventional conforming loan, the most common type of mortgage. Lenders are required by law to evaluate a borrower’s “ability to repay,” and the 28/36 rule helps them assure you’re not over-extending yourself. That said, many lenders will allow a DTI of up to 45% on conventional loans, and there may be wiggle room in the ratios for FHA, VA and USDA loans as well.

Example: The 28/36 rule for a $500,000 home purchase

Applying the 28/36 rule in today’s high-priced market

With the current market’s record-setting home prices and high mortgage rates, is it really realistic to limit your housing spend to just 28% of your income?

For example, the 28/36 rule doesn’t account for your credit score. If you have very good or excellent credit, a lender might give you more leeway even if you’re carrying more debt than what’s considered ideal. This is known as a “compensating factor” on your mortgage application, and it can help you get approved for a larger loan amount.

Another thing to consider is that the rule does not account for the recent inflation of costs for other goods and services. For example, say you have two children under the age of 4 that need full-time childcare. That cost alone could rival your mortgage payment. The 28/36 rule doesn’t account for this, so you’ll need to factor it in at least temporarily. Similarly, the rule doesn’t account for typical fluctuating expenses like groceries and transportation, which if you have a larger household, you’ll need to pay for.

Unfortunately, many homebuyers today have no choice but to spend more than 28% of their gross monthly income on housing. This could be due to a variety of factors, including the gap between inflation and wages and skyrocketing insurance premiums in some popular locations, like Florida.

How to improve your DTI ratio

If your debt and income don’t fit within the 28/36 rule, there are steps you can take to improve your ratios, though it might require some patience. Start by paying down debt. Not only will this help your DTI ratio, but it could boost your credit score, too. You can also take steps to grow your income over the next year or two. While that may not be what you want to hear if you want to buy a home now, it’s better than getting in over your head with a worse interest rate.

If time isn’t your friend, consider whether you could settle for a less expensive home or a more affordable location. Look into condos or townhouses in your desired area, which can make you a homeowner for considerably less than the price of a single-family home. Just keep in mind that these can come with large HOA fees, and may not appreciate as much as a single family home.

A local real estate agent can help you find options that fit both your needs and your budget. And see if you are eligible for any local or state down payment assistance programs to help you pay more money upfront. A bigger down payment reduces the size of your mortgage loan, which can help you better afford the monthly payment within the 28/36 parameters.

Frequently asked questions

• How much house can I afford with a $150,000 salary?
  

  Applying the 28/36 rule to an annual salary of $150,000, you should spend no more than $3,500 per month on housing. Your credit score, type of mortgage loan, interest rate and location will all play a factor in how much your monthly mortgage payments will be.

• Is the 28/36 rule before or after taxes?
  

  The 28/36 rule is based on gross income, so that’s before taxes.

• Should I spend more than 36%?
  

  The 36 number is a guideline, not a law — many lenders allow a higher DTI ratio. However, before you commit to a bigger loan or spending more, ask yourself: How does paying more for my mortgage impact my ability to achieve other financial goals? This might mean fixing up the house you intend to buy, saving for retirement, paying tuition or investing. Consider how your mortgage payment affects your monthly budget, too: Will you have enough left over to cover the remaining essentials? Lastly, take into account how much more you’d be spending on interest with a larger loan amount. This might not matter as much if you don’t plan to stay in the home very long, but if you’re in it for the next 30 years, it adds up to a significant cost.