Often times you don’t know how much home that you can afford with out any type of guidance. Even more so, your eyes can be much larger than your wallet. As a rule of thumb, borrowers can use the 28/36 rule to get an idea of where their mortgage payments should be every month. This tool is something to keep in your back pocket while your house shopping so that you don’t get in to a situation where you end up being house poor.
The 28/36 Rule
Lenders usually apply a standard called the “28/36 rule” to your debt-to-income ratio to determine whether you’re loan-worthy. The first number, 28, is the maximum percentage of your gross monthly income that the lender will allow for housing expenses. The total includes payments on the mortgage loan, mortgage insurance, fire insurance, property taxes, and homeowner’s association dues. This is usually called PITI, which stands for principal, interest, taxes, and insurance.
The second number, 36, refers to the maximum percentage of your gross monthly income the lender will allow for housing expenses PLUS recurring debt. When they calculate your recurring debt, they will include credit card payments, child support, car loans, and other obligations that are not short-term.
28/36 Rule Uses to Determine Affordability
Let’s say your gross earnings are $4,000 per month. $4,000 times 28% equals $1,120. So that is the maximum PITI, or housing expense, that a typical lender will allow for a conventional mortgage loan. In other words, the 28 figure determines how much house you can afford.
Now, $4,000 times 36% is $1,440. This figure represents the TOTAL debt load that the lender will permit. $1,440 minus $1,120 is $320. So if your monthly obligations on recurring debt exceed $320, the size of the mortgage you’ll qualify for will decrease proportionally. If you are paying $600 per month on recurring debt, for example, instead of $320, your PITI must be reduced to $840 or less. That translates to a much smaller loan and a lot less house.
Bear in mind that your car payment has to come out of that difference between 28% and 36%, so in our example, the car payment must be included in the $320. It doesn’t take much these days to reach a $300/month car payment, even for a modest vehicle, so that doesn’t leave a whole lot of room for other types of debt.
Your DTI is just as important as your credit history. Please read this article to find out more about your debt to income ratio.