The 28/36 rule, explained
Quick insights
- The 28/36 rule is a tool lenders could use to assess an applicant’s potential risk for a new loan, specifically a mortgage.
- The rule suggests that a borrower use no more than 28% of their income on housing, and no more than 36% of their income on overall debts.
- Even if you are not planning to buy a home soon, applying the 28/36 rule to your finances can help improve financial stability and your appearance to potential lenders.
Whether you’re preparing to buy a home, move into a new apartment or simply want to monitor your spending, learning about the 28/36 rule can help. In this article, we’ll describe how the rule applies to home affordability, give examples and examine potential implications of exceeding the rule.
What is the 28/36 rule?
The 28/36 rule suggests that a borrower uses 28% of their gross income on housing and 36% of their gross income on all their debt. These are two components:
- 28%: No more than 28% of the borrower’s gross income should be spent on housing.
- 36%: No more than 36% of the borrower’s gross income should be spent on debt payments and housing. This is also known as your debt-to-income (DTI) ratio.
The 28/36 rule is one of several rules that can be used to assess one’s finances. Different metrics may be helpful (or relied on) by various lenders and individuals alike to calculate how much loan someone can afford.
Example of the 28/36 rule
Amy earns $6,000 per month. When she applies for her mortgage, she provides documentation showing car loan and credit card payments total $480 per month (8% of her income). The mortgage she is applying for would cost $1,680 per month (28% of her income). Her potential debts (including housing, car and credit card) amount to 36% of her income. Here’s a breakdown:
- Amy’s gross income: $6,000 per month
- Existing debts: $480 per month (8%)
- Potential mortgage: $1,680 per month (28%)
- Debts + mortgage: $2,160 total per month (36%)
Why is the 28/36 rule important for homebuyers?
The 28/36 rule might help you understand and organize your finances. Documentation showing your income and debts is usually required when you apply for a mortgage. As part of its assessment, a lender may rely on the 28/36 rule to determine an applicant’s ability to repay the loan. Depending on the lender, you may be offered different rates or terms based (at least in part) on your DTI.
Knowing your DTI before you apply for a mortgage loan can give you time to make changes to your financial picture. For example, if your overall debts have crept up, you may want to address them before pursuing a mortgage or take other steps based on your financial situation. Therefore, understanding the 28/36 rule can help you see your finances through the eyes of a lender.
Calculating your own 28/36 figures
Here’s how you can calculate these figures using your own finances.
- Identify your monthly gross income.This is the amount you earn before taxes are taken out or other deductions are made. If you are paid by a regular paycheck, the gross pay is typically printed on the check. If you are receiving income from multiple sources, be sure to total them here.
- Calculate 28% of your gross income. Written simply, the formula is: income x 0.28.
- Calculate 36% of your gross income. Find this number by multiplying your gross income by 0.36.
- Assess your figures. To see if you follow the 28/36 rule, the 28% figure should align with your housing costs. Then, when you add your debts, is the overall total beyond 36% of your gross income?
Why gross income is used for this calculation
Using gross income for 28/36 rule calculations provides a more standardized, verifiable metric. The alternative is your net pay, which varies based on taxes and other potential deductions that vary by individual situation. Using your gross income will help align your own 28/36 calculations with what a lender might evaluate if you apply for a loan.
Implications of exceeding the 28/36 rule
Even when you are not seeking a new loan, the 28/36 rule can serve as a helpful guideline to maintaining healthy finances over time. Depending on your circumstances, discovering that your housing costs and debt (or both) are on the higher side may indicate a need to rearrange financial priorities. Overspending on these categories, important as they are, can make it more difficult to respond to short-term financial needs (such as unexpected expenses) or save for the future.
In summary
Familiarizing yourself with the 28% mortgage rule can be helpful if you’re preparing to buy a home soon. Meanwhile, the 28/36 rule is about knowing the sort of financials lenders might look for. Understanding that before you apply for a loan might empower you to make changes, potentially for a favorable outcome. Even if you are not actively seeking a new home, it can be helpful to check in on your finances and adjust for greater stability over time.
