What is the 28 36 Rule and How to Use It for Home Buying?

The 28/36 rule is a widely used guideline in the lending industry that helps determine how much a borrower can reasonably afford to spend on housing and other monthly debt obligations. This rule was put in place to ensure that borrowers do not overextend themselves, as it can lead to financial difficulties down the road. Here are some key things to keep in mind with the 28/36 rule:
  • Housing expenses: Your housing expenses should not exceed 28% of your total monthly income. This includes your mortgage payment, property taxes, and any homeowner association fees.
  • Debt obligations: Your total monthly debt obligations, including your mortgage payment, credit card bills, car loans, and other debts, should not exceed 36% of your total monthly income.
  • Importance of the rule: It’s important to adhere to the 28/36 rule to ensure that you don’t end up with a mortgage or other debt that you can’t afford. Overextending yourself can lead to serious financial problems, including foreclosure and bankruptcy.
  • Exceptions: While the 28/36 rule is a common guideline, there may be circumstances where it’s not appropriate. For example, if you have a high income and minimal debt, you may be able to afford a higher housing expense.
  • Importance of budgeting: Ultimately, the 28/36 rule is just a starting point, and it’s important to develop a comprehensive budget that takes into account all of your expenses and financial goals. By carefully managing your income and debt, you can ensure that you’re on track to achieve your financial objectives.
  • Remember that the 28/36 rule is simply a guideline, and it’s up to you to ensure that you’re making financially responsible decisions. By keeping your debt and housing expenses in check, you can enjoy the peace of mind that comes with financial stability.
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    The Basics of the 28/36 Rule

    The 28/36 rule is a concept that has been around for a while in the financial industry and in the context of borrowing for a home. The rule is essentially a guideline that dictates how much of your monthly income should be spent on housing and other debt obligations, to avoid being lent more money than you can realistically afford to pay back. In more simple terms, the rule suggests that you should not spend more than 28% of your income on housing, and your total debt obligations should not exceed 36%.

    Understanding Your Monthly Income

    Before you can start applying the 28/36 rule, it is important to have a solid understanding of your monthly income. Your income includes any money you receive on a regular basis, whether that’s from your job, freelance work, or even rental income. In most cases, your monthly income will be your gross income, which is your pre-tax earnings. Gross income is important in this context because it is used to determine your maximum borrowing capacity. However, it is important to note that your net income, which is your earnings after taxes and other deductions, is what you should actually use to determine your personal budget.

    Determining Your Housing Expenses

    Once you know your monthly income, the next step is to determine your housing expenses. These are the costs associated with owning or renting a home, such as mortgage or rent payments, homeowner’s insurance, property taxes, and utilities. Generally, a borrower should not spend more than 28% of their monthly income on housing expenses. It’s critical to keep in mind that this 28% is a guideline, not a hard-and-fast rule. Some people may be able to afford higher housing expenses, while others may need to stay below 28% to stay financially stable.
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    To calculate your maximum housing budget, multiply your monthly income by 0.28. For example, if you earn $5,000 per month, your maximum housing expenses should not exceed $1,400.

    Taking into Account Your Total Debt Obligations

    In addition to your housing expenses, you also need to consider your total debt obligations, which includes any money you owe to lenders, such as credit card debt, student loans, and car payments. The 36% limit includes your housing expenses, so after calculating your maximum housing expenses using 28%, the remaining 8% is what you can use to pay off other debts. It’s important to note that anything above the 36% limit is a red flag to lenders. They may be hesitant to lend you money if they believe you will have trouble repaying your debts. To determine your maximum debt obligations, multiply your monthly income by 0.36, then subtract your maximum housing expenses from that amount. For example, if you earn $5,000 per month and your maximum housing expenses are $1,400, your maximum debt obligations should not exceed $800 per month.

    Why the 28/36 Rule is Important

    The 28/36 rule is important because it serves as a guide to help borrowers avoid borrowing more than they can realistically afford to pay back. By limiting housing expenses and total debt obligations, borrowers can ensure that they don’t become financially overextended, which can lead to missed payments and other financial problems. Additionally, the 28/36 rule can help borrowers avoid being caught in a vicious debt cycle, which can result in financial ruin.

    Applying the 28/36 Rule to Real-Life Situations

    To illustrate how the 28/36 rule works in practice, let’s take a hypothetical example. John earns $4,000 per month and is looking to buy a house. Using the 28/36 rule, his maximum housing expenses should not exceed $1,120 (28% of $4,000), and his maximum total debt obligations should not exceed $440 (36% of $4,000, minus $1,120).
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    John applies for a mortgage and is approved for a loan of $250,000. His monthly mortgage payment is $1,200, which includes principal, interest, taxes, and insurance. Based on the 28/36 rule, his housing expenses fall within the recommended maximum. However, John also has a car loan, credit card debt, and student loans, which all together total $600 per month. To determine whether he meets the 36% maximum limit, John subtracts his maximum housing expenses from his maximum total debt obligations, which leaves $320 ($440 minus $120). Since his other debts amount to $600 per month, John is exceeding the recommended limit and may have trouble repaying his debts or keeping up with his mortgage payments.

    Alternatives to the 28/36 Rule

    While the 28/36 rule is a common guideline, it is not the only option available. Some lenders use a similar but slightly different ratio, such as the 30/40 rule, which allows borrowers to spend up to 30% of their income on housing and up to 40% on total debts. However, keep in mind that these guidelines are just that: guidelines. Each borrower’s financial situation is unique, and it is up to them to determine how much they can realistically afford to spend on housing and other debts. Ultimately, the key is to borrow only what you need and what you can afford to pay back, while keeping in mind the importance of saving and investing for the future.

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