What is the Rule of 35 in Real Estate Investing?

The rule of 35 in real estate is a criterion used by lenders to ascertain whether a borrower can afford to repay a loan. Essentially, it stipulates that a borrower should spend no more than 35 percent of their monthly take-home income on mortgage payments, including interest and principal. This rule is important because it ensures that borrowers do not overextend themselves and that lenders do not approve loans that the borrower cannot repay. Below are the key takeaways of the rule of 35 in real estate.

Under the rule of 35, lenders assess a borrower’s ability to repay the loan by looking at their monthly take-home income.

The borrower’s monthly mortgage payments should not exceed 35 percent of their take-home income.

The 35 percent figure includes the principal, interest, and any other fees associated with the loan.

The rule of 35 applies whether the borrower is self-employed or an employee.

This rule helps prevent overborrowing by ensuring that borrowers don’t take loans that they cannot repay.

Overall, the rule of 35 is an essential principle in real estate lending. It helps lenders and borrowers stay realistic about how much they can afford to borrow and repay, helping everyone involved make sound financial decisions.

Understanding the 35% Principle in Real Estate

The 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 Eligibility

When 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 Approval

The 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 Borrowers

The 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.

Factors That Lenders Consider When Applying the 35% Rule

While the 35% principle is a key determinant of a borrower’s affordability, other financial factors also impact loan approval. These factors include the borrower’s credit score, down payment size, employment history, debt-to-income ratio, and even projected earnings. In particular, the debt-to-income ratio is a vital piece of the determination, making up a significant part of the assessment. Lenders prefer to see a ratio below 43%, which includes all monthly debts, not just what will come with homeownership.

Debunking Common Misconceptions Surrounding the 35% Principle

One primary misconception surrounding the 35% principle is that it is a universal rule and lenders will rigidly stick to it regardless of individual circumstances. However, lenders understand that each borrower could require unique accommodation and will often consider the situation when they decide on approving or denying the loan. For some borrowers, the 35% limit might not be an attainable goal, but that does not imply they will not be approved. Ultimately, the 35% principle is a crucial aspect of determining affordability when considering taking out a loan for any property. Borrowers must assess their finances and budget rigorously to ensure that their monthly housing costs do not exceed this standard. By following the 35% principle, borrowers can confirm they will not be house poor and can sustainably maintain their standard of living within their budget.