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Before you take out a mortgage, consider that 28/36 rule to make sure you are not overwhelmed. How does the rule work? It is a sensible way to measure your debt load before submitting an application, and most lenders are already using it to approve loans. So you might as well run the numbers to see how they stack up. This is how it works.
What is the 28/36 rule?
Perhaps you have heard the phrase “House poor“? It describes the phenomenon where a homeowner invests all of their financing and money in owning a home – to the point that they cannot cover other expenses like unexpected repairs or healthcare costs. Of course, this can result in homeowners defaulting on their mortgage. To avoid this, lenders like to see two specific debt-to-income ratios known as the 28/36 rule, broken down as follows:
- Your total real estate costs shouldn’t be higher than 28 percent Your gross monthly income. Known as “Front-end ratio”This covers housing costs including mortgage, property tax, mortgage insurance, and homeowner association fees (although for some reason utilities are not included). To know if your front-end rate exceeds 28%, add up all of your housing costs (or potential housing costs) and divide the total by your gross monthly income. Then multiply that number by 100 to get your front-end ratio.
- Your total debt (including your real estate expenses) cannot exceed 36 percent Your gross monthly income. Known as your “debt-to-income” or “Back end“Ratio this includes credit cards, student loans, personal loans, car loans, alimony, child support and utility bills. To know if your back-end quota exceeds 36%, add up all of your monthly housing and consumer debt and divide the total by your gross monthly income. Then multiply that number by 100 to get your back-end ratio.
What if my debt crosses the 28/36 threshold?
All is not lost. You can still qualify for loans if you have excellent credit, and Insider advises Government-sponsored FHA, VA, or USDA loans will approve slightly higher quotas.
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Note, however, that applying for a mortgage becomes one pull hard on your creditthat may temporarily affect your creditworthiness. It is for this reason that you should complete the numbers before applying for a mortgage as it will give you an idea of whether you are eligible without the tough credit check. If you don’t qualify, financial experts recommend waiting to buy a home until you have more income or a larger down payment.