Understanding the 35% Principle in Real EstateThe 35% principle is a guideline utilized by lenders to estimate whether a borrower has the financial ability to repay a loan. Essentially, lenders use this principle to determine whether a borrower’s income is sufficient to cover the costs associated with owning a property, such as property taxes, mortgage payments, insurance, and maintenance fees. If a borrower can incur all of these costs with no more than 35% of their take-home pay, they are deemed financially stable and therefore eligible for the loan.
The Role of Lenders in Determining Borrower EligibilityWhen approving loans, lenders have a responsibility to ensure that the borrower has the means to repay the debt. Thus, they ask for information such as credit score, income, debt-to-income ratio, employment history, and assets. Using these factors, they can determine whether a borrower has the ability to afford the loan or not. The 35% principle is just one of many financial circumstances that lenders consider when determining a borrower’s eligibility.
Why 35% is Considered a Key Factor in Loan ApprovalThe 35% principle is considered an important benchmark because it is viewed as a sustainable amount for households to spend on housing expenses. If the percentage exceeds 35%, there is a higher risk of default and foreclosure. In contrast, less than 35% means the borrower has more disposable income, which minimizes the chance of financial stress.
How the 35% Principle Impacts Affordability for BorrowersThe 35% principle can genuinely impact a borrower’s ability to afford a home. For example, suppose a borrower earns $5,000 per month in take-home pay. If the borrower could only afford a mortgage payment of $1,500 per month, their total monthly housing expenses should not exceed $1,750. A property with property taxes or homeowner’s insurance higher than $250 per month could ultimately disqualify the borrower from receiving a loan or significantly increase their mortgage payments to stick within the 35% limit. Examples of 35% Principle in Action: Real Estate Scenarios
- Scenario 1: A prospective borrower wants to buy a home in a neighborhood where the property taxes are steep.
- Scenario 2: A borrower hoping to purchase a rental property and have tenants pay the majority of the fees, leaving them with the mortgage.
- Scenario 3: A borrower determined to pay more than 35% of their income on housing expenses, confident in their savings habits and lifestyle choices.