When buying a house, you need to be extremely careful with your finances so you don’t put yourself in a difficult position that you’ll have to endure for years to come. Don’t ever buy a house you can’t actually afford. Otherwise, it can have very serious implications for your finances.
It pays to listen to mortgage lenders when they say you can’t really afford to take out a loan in a particular amount or interest rate as they’re usually right about it. In fact, they’re probably just following the 28/36 rule of mortgage lending. This rule of thumb is followed by many lenders that serve as a sort of guide when assessing borrowers’ applications. Let’s explore what the 28/36 rule is and how it affects your finances.
What is the 28/36 Rule?
The 28/36 rule is more of a common-sense rule that lenders, borrowers, and brokers use to calculate the amount of debt an individual or household should assume. It’s not exactly a hard rule but more of a guide that has probably saved many people from being buried in a mountain of debt.
The 28/36 rule is basically a mortgage benchmark that’s based on the debt-to-income (DTI) ratios that homebuyers can use to avoid overextending their finances. It simply states that borrowers shouldn’t use more than 28% of their gross monthly income toward housing expenses. On the other hand, a borrower should also put no more than 36% of their gross monthly income for all debt services, which includes housing.
Calculating Debt Using the 28/36 Rule
Here’s how lenders calculate your debt using the 28/36 rule. Let’s say you earn about $5,000 a month before taxes or other deductions from your paycheck. According to the rule, your monthly mortgage payment shouldn’t exceed $1,400 ($5,000 x 28%), and that your total monthly debt payments, which includes housing, shouldn’t exceed $1,800 ($5,000 x 36%). By looking at those figures, a lender can easily recommend if a borrower should pursue their mortgage application or not.
How the 28/36 Rule Applies to Borrowers and Lenders
For borrowers, the 28/36 rule is a helpful guide to keep their finances in check and even plan their monthly budgets. Following the rule can actually help you improve the chances of credit approval even if you’re not applying for credit.
For lenders, on the other hand, the rule can be one of the criteria used to approve credit applications. Although lenders refer to many criteria when assessing loan applications, the 28/36 rule can be a great indicator of a borrower’s ability to pay off their mortgage. They can look at the borrower’s credit score as well as their debt-to-income ratio to influence their decision. By applying the 28/36 rule, lenders can determine how much debt a borrower can safely assume based on their income, other obligations, and financial needs. If they exceed the 28/36 rule parameters, it would be difficult for them to sustain payment and have a high risk of defaulting.
Conclusion
Following the 28/36 rule is a simple yet practical guide to help both borrowers and lenders make better financial decisions. While it isn’t a rule set in stone, it works to give you a quick view of the ideal debt you should be paying for compared to your income and financial needs.
Mortgage City is a licensed mortgage originator offering home purchase loans to help you fulfill your financial loans. If you’re buying a house or refinancing one, our team can help you with all your mortgage needs, from conventional loans, to USDA and VA loans. Contact us today at (248) 930-8709 to get a free mortgage rate quote. We are licensed in multiple states, including Michigan, Florida, New Hampshire, and Ohio.
