The 28/36 Rule
Kathy Riggs September 27th, 2009
Almost every profession, hobby or business market has a “rule.” In photography it’s the F-16 rule, in many areas of business it’s the 80/20 rule, in mortgage matters it is the 28/36 rule.
The 28/36 rule is a tried and true meter of how much house you can afford and how much a lender is willing to loan. It is the debt to income ratio. While, you should always consult a lender for a pre-approval – and it is the first thing you should do before you begin house hunting – it is a good idea to see how the 28/36 rule applies to your own finances.
The 28 portion of the rule means that a lender will not allow more than 28 percent of your gross monthly income to be alloted to housing expenses. The lender’s definition of housing expenses means the total of the mortgage principal, the mortgage insurance, the property taxes, the hazard insurance and the homeowners association dues. For instance if your gross monthy income is $4,000, 28 percent of $4,000 is $1,120. That is the maximum a lender will allow you for housing expenses. In other words, that is how much house you can afford.
The 36 percent is the portion of your gross monthly income that is allowed for the housing expenses PLUS recurring debt such as car payments.
Now, $4,000 times 36 percent is $1,440. This figure represents the TOTAL debt load that the lender will permit. $1,440 minus $1,120 is $320. So if your monthly obligations on recurring debt exceed $320, the size of the mortgage you’ll qualify for will decrease proportionally. If you are paying $600 per month on recurring debt, for example, instead of $320, your PITI must be reduced to $840 or less. That translates to a much smaller loan and a lot less house.
The moral of the story here is that too much debt can ruin your chances of qualifying for a home mortgage. Remember, the debt-to-income ratio is something that lenders look at separately from your credit history. That’s because your credit score only reflects your payment history. It’s a measurement of how responsibly you’ve managed your use of credit. But your credit score does not take into account your level of income. That’s why the DTI is treated separately as a critical filter on loan applications. So even if you have a PERFECT payment history, but the mortgage you’ve applied for would cause you to exceed the 36 percent limit, you’ll still be turned down for the loan by reputable lenders.
The 28/36 rule for debt-to-income ratio is a benchmark that has worked well in the mortgage industry for years. Unfortunately, with the recent boom in real estate prices, lenders have been forced to get more “creative” in their lending practices. Whenever you hear the term “creative” in connection with loans or financing, just substitute “riskier” and you’ll have the true picture. Naturally, the extra risk is shifted to the consumer, not the lender.
In today’s mortgage world there are many more options than the traditional 30-year fixed rate so a visit to your mortgage officer is always in order before you begin house hunting. Some loan programs such as VA will calculate the expenses using a 29/46 rule.
In any case looking at your budget and applying the 28/36 rule will be time well spent. You will have a better handle on the response you may receive from your lender.
on the lighter side…
Q. How long is a temporary mortgage? A. Until the bank forecloses.
Open House Sunday, October 4, 2009
Join me for an open house from 2-4 p.m Sunday, Oct. 4, 1903 Hardee Road, Kinston NC.
SHAMELESS PLUGS
I have a client interested in purchasing an existing poultry farm. I also have some clients very interested in purchasing several tracts of 60 to 80 acres of farm land.
Call me at 252-939-2432 or email me at kriggs@kathyriggs.com for more information.