Home loans make it possible for many people to pursue the American Dream. Without them, most of us wouldn’t be able to purchase a home. Today, lenders are able to approve applicants quickly, thanks to technology and advances in the industry. But just because you’ve been approved for a loan doesn’t mean you should take out the whole amount.
Generally, experts recommend sticking to something called the “28/36” Rule. Below, we’ve explained exactly what this is and why it’s good advice.
The “28/36 Rule” – What Does It Mean?
The 28/36 Rule is a guideline that helps borrowers determine how much home they can afford. According to this principle, your housing payment shouldn’t be more than 28% of your monthly income and 36% of your total debt. Following this guideline helps borrowers calculate how much debt they can take on safely without putting their financial future at serious risk.
The 28/26 Rule isn’t used just by borrowers. It’s used by lenders too. Lenders want to know that you’ll be able to afford your monthly payments. The less risk there is, the more likely they are to approve your loan application.
Let’s take a closer look at the 28/36 Rule and what it means exactly.
28% – The Front-End Ratio
This first number (ideally 28%) is called the “front end ratio”. To calculate, take the total cost of your housing payment (mortgage plus interest and property taxes) and divide it by your monthly income. If the number is higher than 28%, you may want to consider buying a cheaper home. Ideally, you want this number to be 28% or less.
36% – The Back-End Ratio
The second number in the 28/36 Rule is called the “back end ratio”. This figure is also referred to as your “debt-to-income ratio.” To calculate, take your total monthly debt (credit card payments, student loans, car payment, etc.) and divide it by your total monthly income. The number you end up with should be 36% or less. If it’s higher than 36% you may have a harder time getting approved for a home loan.
Why Does the 28/36 Rule Matter?
The 28/36 Rule is important because it helps borrowers make good financial decisions. Homeownership is a wonderful experience, and you should get to enjoy it. The last thing you want is to be stressed out because you feel like your house is more expensive than you can afford. Principles like the 28/36 Rule are used to protect borrowers and set them up for success.
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