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“How much can I afford to pay for a house?” It’s a question all hopeful homebuyers ask themselves. Coming up with a monthly payment that works for you might be easy — simply subtract your monthly expenses from your gross monthly income. Unfortunately, that number might not align with the amount of money a bank will lend you. That’s because banks and other lending institutions have a formula they often use to determine what you can afford: the 28/36 rule.
What is the 28/36 rule?
This rule of thumb dictates that you spend no more than 28 percent of your gross monthly income on housing costs, and no more than 36 percent 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, all the 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 percent): The maximum percentage of gross monthly income you should spend on housing.
- Back-end ratio (36 percent): 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 law — it’s really 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. Most lenders employ it to ensure you don’t overextend yourself financially — lenders are required by law to evaluate a borrower’s “ability to repay,” and the 28/36 rule helps them do just that. That said, many lenders will allow a DTI of up to 45 percent 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
- Say you’re buying a home priced at $500,000 with a 20 percent down payment, and you’re getting a 30-year, fixed-rate mortgage at 7 percent. With those figures, your monthly principal and interest payments would come to $2,210, according to Bankrate’s mortgage calculator.
- Add another $400 or so to cover the cost of your property taxes and homeowners insurance premium, both of which will vary depending on where you live, and your housing costs for the month would total $2,610.
- To stay within the 28 percent threshold, you’d need to bring in at least $11,666 per month, or about $140,000 per year, to afford the $500,000 home. (Keep in mind that this does not include the upfront expenses of a down payment and closing costs.) To keep all of your debt to no more than 36 percent, you’d be limited to spending $4,200 in total per month.
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 percent 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.
The rule also does not account for your specific personal circumstances. Unfortunately, many homebuyers today have no choice but to spend more than 28 percent 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.
If you can’t align with those guidelines, consider it a warning that you’re carrying too much debt or buying too much house.
— Greg McBride, Bankrate Chief Financial Analyst
“The rule is still practical today,” says Greg McBride, CFA, chief financial analyst for Bankrate. “Given today’s high home prices and high mortgage rates, prospective homebuyers might be dismissive of the rule and think it is a relic of the past. But if you can’t align with those guidelines, or aren’t even close, consider it a warning that you’re carrying too much debt or buying too much house.”
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. “Consider taking time to pay down debt and see further income growth that would make homeownership more tenable in another year or two,” says McBride. “That’s not what you want to hear if your heart is set on buying a home now — but is it worth potentially biting off more than you can chew?”
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. 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.
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