What is the 28/36 rule for home affordability?

“How much can I afford to pay for a house?” It’s a question all hopeful homebuyers ask themselves. Coming up with a number 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 for home affordability?

The 28/36 rule 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 your 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 called a “rule,” the 28/36 rule is 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 as a rule of thumb to ensure you don’t overextend yourself financially. Lenders are required by law to evaluate a borrower’s “ability to repay” — the 28/36 rule helps them do just that. That said, it’s just a guideline, not law. Many lenders allow a DTI of up to 45 percent on conventional loans. For an FHA loan, the front-end could go up to 31 percent and the DTI maximum could be as high as 50 percent. On a VA loan or USDA loan, the ideal DTI ratio is 41 percent.

Example of the 28/36 rule on a $500,000 home

Home affordability: Is it possible today?

With the current market’s near-record home prices and the highest mortgage rates we’ve seen in two decades, how realistic is it to limit your housing spend to just 28 percent of your income?

“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.”

Downsides to the 28/36 rule

Broad guidelines like the 28/36 rule do not account for your specific personal circumstances. Unfortunately, many homebuyers today do have 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, higher mortgage rates and home prices and skyrocketing insurance premiums in some popular locations, like Florida.

The 28/36 rule also 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.

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 take some time. “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.

FAQs

• How much house can I afford with a $150,000 salary?

  Applying the 28/36 rule to an annual salary of $150,000, you should spend no more than $3,500 per month on housing. Your credit score, type of mortgage loan, interest rate and location will all play a factor in how much your monthly mortgage payments will be.
  

• Should I spend more than 36 percent?

  The 36 number is a guideline, not a law — many lenders allow a higher DTI ratio. However, before you commit to a bigger loan or spending more, ask yourself: How does paying more for my mortgage impact my ability to achieve other financial goals? This might mean fixing up the house you intend to buy, saving for retirement, paying tuition or investing. Consider how your mortgage payment affects your monthly budget, too: Will you have enough left over to cover the remaining essentials? Lastly, take into account how much more you’d be spending on interest with a larger loan amount. This might not matter as much if you don’t plan to stay in the home very long, but if you’re in it for the next 30 years, it adds up to a significant cost.
  

• Is the 28/36 rule before or after taxes?

  The 28/36 rule is based on gross income, so that’s before taxes.